Thinking Big: Going Global

From Covid-19 disruption to trade tensions, there can be little doubt that the world is becoming more fragmented. Markets around the world are less in sync because of country specific divergences in Covid-19 recovery, central bank policy and valuations. Different markets may present varying upside opportunities, as each economy also has unique idiosyncratic risk. International investing – meaning portfolio construction with diversified geographical exposure - may be source of return and resilience in a world of unknowns. The unprecedented uncertainties in the market are changing the nature of alpha generation - diversification is now key to portfolio outperformance and resilience1. There are three main drivers to the merits of international investing:

1. Covid-19 recovery

Levels of economic activity restart varies enormously across the globe. Some countries have demonstrated faster-than-expected economic recovery while others are still struggling to combat Covid-19. Asia has seemingly begun the long journey back to economic normalcy, but regions such as the US and Europe are now seeing daily Covid-19 infections hitting record highs again. Political leaders have been struggling to find ways to control Covid-19 while limiting the negative impact on the economy. Nonetheless, the control of the virus is central to an economic recovery. Meanwhile, vaccine development is a potential influence for the economic growth outlook - the timing of widely available Covid-19 vaccines may impact the global restart. Developed markets, which have better access to vaccines compared to emerging markets, could potentially catch up on economic recovery. A geographically diversified portfolio can offer exposure to both the current economic recovery in Asia, as well as a potential vaccine-driven turnaround of developed markets.

2. Policy divergence

Global monetary and fiscal policy 2020-2021

Covid-19 recovery

 

Sources: BlackRock Investment Institute with data from Haver Analytics, November 2020. Notes: The green bars show estimates of discretionary fiscal measures in 2020 to offset the Covid-19 shock. The light green bars show fiscal measures for 2021, based on estimates from brokers. The green bars show the estimated impulse of monetary growth in China, measured as total social financing growth minus local government debt purchases. There is no guarantee forward looking estimates will come to pass.

Index to MSCI

In the face of the unprecedented hit to economic activities brought about by Covid-19, policymakers and central bankers around the world have responded swiftly by using a variety of fiscal and monetary tools. Many countries have imposed extraordinarily aggressive monetary policies to boost expectations of inflation in order to suppress real borrowing costs and, consequently, encourage more credit market activity. However, the power of central banks is limited, and monetary policy alone cannot generate enough growth - fiscal policy must keep playing a key role to sustain households and businesses through the income shock.

Risks of policy fatigue are rising, especially for US and Europe. UK has spent close to 20% of its 2020 GDP in bond purchase programs while the US hasn’t been too far behind, at 13% of GDP,  more than what China has spent on monetary support via total social financing (only 3% of total GDP). There are growing concerns that the US recovery may lose steam without a further stimulus package, as a divided government could be constrained in implementing key policy plans including large fiscal spending. In the meantime, the European Union is still under negotiation to reach a coronavirus stimulus deal. Any delay in the budget negotiations could postpone the disbursement of funds into the new year, a situation the hardest-hit member states are hoping to avoid. It is important for investors to consider this risk and secure returns through diversification.

3. Valuation differentials

Equity sources of total return - YTD

Equity sources of total return

 

Source: Refinitiv DataStream, MSCI and BlackRock Investment Institute Nov 19, 2020 Notes: The bars show the breakdown of each market’s year-to-date return into dividends, earnings growth and multiple expansion. The dots show each market’s year-to-date returns. Earnings growth is based on the year-to-date change in 12-month forward I/B/E/S earnings estimates. World is defined as the MSCI All Country World Index. Returns are based MSCI indexes.

Global markets have rallied sharply from March lows, driven by the policy revolution and economic restart. Yet, returns and valuations among markets continued to diverge. In the US where the market has a higher technology composition, earnings decline in the broader market was partly offset by strong growth from stay-home and technology stocks. However, total returns were primarily driven by growth in multiples – valuation re-rating of US stocks has outpaced other markets. In Europe where markets are more concentrated in cyclical sectors, company earnings were severely hit by lockdowns. Dividend Yields were eroded after European regulators’ dividend ban. In addition to low earnings and dividends, UK and Eurozone are trading near historic high PE ratios, making these markets less appealing from a valuation perspective. 

Stretched valuations could pose significant risk as illustrated by September’s equity selloff. It is important for investors to balance their portfolios with markets that are less expensive. Emerging markets and Asia ex Japan saw less impact on earnings thanks to better Covid-19 control, hence returns may be more sustainable. This reaffirms our view that global investing could provide more balanced risk-return exposure to investors.

Bottom Line

The Covid-19 crisis has laid bare the fragilities of our economies and societies, and accelerated divisions in the world. Investors may consider holding a well-diversified and nimble portfolio to navigate this volatile time. We believe investors should consider focusing on return sources that may provide diversification, offering potential resilience in a world of unknowns.

Investment considerations

  • Geopolitics: Global or regional geopolitics tension remains a key risk
  • Covid-19: Any resurgence of Covid-19 will post risks in slowing down global economic recovery
  • There is no guarantee that a positive investment outcome will be achieved