A Rebound in Global Equities

OCTOBER 30 2013

With the U.S. economic expansion entering its fifth year and the global economic picture improving, it appears equities in Europe and Asia can still rise.

by Scott Minerd, CIO, Guggenheim Partners LLC

U.S. equities have some upside, but investors seeking to maximize returns during the coming period of synchronous global growth should focus on opportunities elsewhere. The total market capitalization of U.S. stocks now exceeds 100 percent of GDP – a level typically associated with full valuation – so it appears that European and Asian equities are better positioned for gains over the next year.

The outlook is extremely favorable for Europe, where systemic risk has largely dissipated. European Central Bank President Mario Draghi has made clear that the ECB will do what is needed for an orderly financial sector restructuring. Peripheral economies now have access to capital markets thanks to lower interest rates and are enjoying an improving fiscal outlook. Lower unit labor costs are also helping periphery nations export their way to a stronger recovery. Improving economic fundamentals will soon flow through to earnings in periphery nations, and equities in larger economies such as Spain and Italy, hard hit during the crisis, could see the most substantial gains.

A simultaneous economic expansion in the United States and Europe should support growth in China. The total market capitalization of Chinese stocks as a percentage of GDP is close to its previous low in late 2008 and more than 60 percent below its 2007 peak, giving Chinese equities highly attractive valuations. Ultra accommodative monetary policy in Japan will likely continue to bolster output there in the short-run.

Chart of the Week

Attractive Equity Valuations in Peripheral and Eastern Europe

With continued monetary easing around the world and signs of a synchronous global expansion taking root, countries that were particularly hard hit over the past few years now present potentially attractive opportunities. Measured by market capitalization as a percent of GDP, Eastern Europe and smaller euro zone peripheral countries now appear to be the most undervalued of major regions worldwide. Major peripheral countries in the euro zone (Greece, Ireland, Italy, Portugal, and Spain) are also below their average level of market cap to GDP over the past 10 years, indicating further room for equity returns, compared to other developed markets. Emerging markets that suffered selloffs over the past few months also remain undervalued, including India, China, and South America.

MARKET CAPITALIZATION TO GDP: % DEVIATION FROM 10-YEAR AVERAGE

Source: Bloomberg, Haver, Guggenheim Investments. Data as of 3Q2013 for market cap, 2Q2013 for GDP. Other EM includes Turkey, Mexico, Korea, Hong Kong, and Taiwan. Southeast Asia includes Malaysia, Philippines, Singapore, Thailand and Indonesia. Other DM includes Australia, Canada, UK, and Switzerland. Euro zone core includes Germany, France, Netherlands, and Finland. South America includes Brazil, Argentina, Peru, Colombia, and Chile. Eastern Europe includes Poland, Czech Republic, Ukraine, Hungary, Bulgaria, Croatia, Latvia, Lithuania, Romania, and Russia. Other Periphery includes Slovenia, Estonia, Slovakia, Malta, and Cyprus.

Economic Data Releases

U.S. Confidence Plunges Due to Government Shutdown, Other Data Mixed

• U.S. retail sales inched down 0.1% in September, the first drop since March. Excluding autos and gas, sales were up 0.4%.
• The Conference Board’s consumer confidence index plunged nine points in October to 71.2, the lowest since August 2011, as the shutdown and debt ceiling debate weighed on consumers.
• University of Michigan consumer confidence was revised lower in the final October estimate, dropping to 73.2 for a third consecutive month of falling confidence.
• Pending home sales dropped 5.6% in September, the largest one-month drop in over three years.
• The S&P/Case-Shiller 20-City Home Price Index reached 12.8% year-over-year growth in August, continuing to make cyclical highs.
• Durable goods orders increased 3.7% in September, but the gain was due to aircraft demand. Durables, excluding transportation, were down 0.1% and non-defense capital goods, excluding aircraft, fell 1.1%.
• Industrial production rose a better-than-expected 0.6% in September, the best month since February.
• Unemployment claims fell less than expected for the week ended October 19, decreasing from 362,000 to 350,000.
• The CPI ticked up 0.2% in September, but the year-over-year reading dropped to 1.2%, a five-month low.
• The PPI in the U.S. inched down 0.1% in September for a year-over-year reading of 0.3%, the lowest in four years.

Continued European Expansion, Japanese Inflation Reaches New Highs

• The euro zone manufacturing PMI rose from 51.1 to 51.3 in October for a fourth month of expansion. The services PMI unexpectedly fell, but remained in expansion at 50.9.
• Euro zone economic confidence grew for a sixth straight month to 97.8, the highest since August 2011.
• France’s manufacturing PMI unexpectedly dropped in the October preliminary release, falling to 49.4 from 49.8. The services PMI also fell.
• The manufacturing PMI in Germany rose to 51.5 in October, staying in expansion for a fourth straight month.
• The German IFO Business Climate Index fell unexpectedly in October to 107.4, the first decrease since April.
• GDP in Spain increased 0.1% in the third quarter, the first quarter of growth in two and a half years.
• U.K. GDP rose 0.8% in the third quarter from the second quarter, the best growth in over three years.
• The HSBC flash manufacturing PMI for China expanded to 50.9 in October, the best reading since March.
• Japan’s CPI rose for a sixth consecutive month, reaching 1.1% year-over-year in September, a five-year high.
• Japanese retail sales jumped 1.8% in September after rising 0.9% in August. September’s gain was the best month since June 2011 in the aftermath of the earthquake.
• Industrial production in Japan rose 1.5% in September, slightly under expectations after a 0.9% decrease the previous month.

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