Preview
In focus: Brighter outlook for undervalued small caps
Banking continues to be a sector where investors may find opportunities for portfolio quality and yield enhancement. Despite concerns surrounding macroeconomic headwinds and interest-rate cuts, we believe compelling valuations relative to fundamentals support the sector’s overall risk/reward potential.
Stock selection is key to identifying the long-term winners that can drive value creation in portfolios. Our focus is on leading institutions with diversified earnings profiles, strong capital ratios and attractive shareholder-return policies.
Investment outlook
In North America, whilst recent attention has focused on the extreme concentration of the US stock market, US equities have enjoyed their strongest earnings growth since early 2022,1 underpinning strong global stock market returns. However, given an expectation for moderating growth and lower-than-expected earnings, we believe investors will be rewarded by focusing on quality metrics like free-cash-flow yield and ROE. With the fastest-growing companies being the most sought after in the first half of the year, many high-quality stocks have been left behind. This is particularly true of dividend-paying sectors such as health care and utilities. Additionally, technology infrastructure around artificial intelligence (AI) is creating increased demand for electricity, providing tailwinds for the higher dividend-yielding utilities sector.
In Asia Pacific, Corporate earnings recovery in the Asia ex-Japan region remains on track, having captured mid-teen profit growth in the second quarter on top of solid margin expansion.2 While a favorable base from last year likely helped, the recovery is broadly in line with our base-case view that US and global recessions are unlikely, as the interest-rate easing cycle kicks off in most major economies. This should set the stage for sustained earnings growth—Asia ex-Japan earnings are expected to rise 27% in 2024 and 16% in 2025.3 However, the growth will likely be uneven across sectors and markets, with South Korea and Taiwan expected to lead the pack in 2024 due partly to a strong showing in the information technology (IT) sector. China’s and Hong Kong’s earnings growth continues to lag the broader market.
In Europe, with moderating inflation in Europe, rate cuts are expected during the remainder of 2024 and early 2025. A key data point in August was the Eurozone Consumer Price Index, which came in at 2.2% (the lowest point in three years but in line with estimates), while core inflation eased to 2.8%. The market continues to price in further interest-rate cuts from the European Central Bank in December and beyond.
Market review: August 2024
Global equities, as measured by the MSCI ACWI Index in US-dollar terms, endured heightened volatility in early August but recovered to collectively gain for the month. As measured by MSCI indexes in US-dollar terms, developed market equities outpaced the MSCI ACWI Index, while emerging markets trailed it. Global value stocks outperformed global growth stocks, but both segments were largely in line with the global benchmark.
The Japanese market was hit by a historic selloff from August 2 to August 5 as concerns over weak manufacturing and employment data in the United States triggered the unwinding of the yen carry trade. Markets elsewhere similarly declined and were pressured further by rotation out of technology majors and mixed corporate earnings. However, sentiment calmed entering the second week of the month amid growing expectations that the Fed will start cutting rates in September (the latest Fed meeting minutes also signaled a September cut). Meanwhile, a flash report showed that manufacturing activities shrank further across major developed economies in August.
Endnotes
- Based on the second-quarter year-on-year earnings growth of the S&P 500. Source: Bloomberg. As of September 2, 2024. The S&P 500 Index includes 500 leading companies and captures approximately 80% coverage of available market capitalization in the US. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
- Source: J.P. Morgan Global Markets Strategy. “Asia ex-Japan earnings tracker.” As of August 26, 2024.
- Ibid.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Equity securities are subject to price fluctuation and possible loss of principal. Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks. There can be no assurance that multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods.
Active management does not ensure gains or protect against market declines.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets. Investments in companies in a specific country or region may experience greater volatility than those that are more broadly diversified geographically. The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries. There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
Investments in fast-growing industries like the technology sector (which historically has been volatile) could result in increased price fluctuation, especially over the short term, due to the rapid pace of product change and development and changes in government regulation of companies emphasizing scientific or technological advancement or regulatory approval for new drugs and medical instruments.