Global Equities: Volatility, Uncertainty and the Aging Bull Market

Scott Berg

Portfolio Manager,

T. Rowe Price Global Equity Fund

Should the uneven nature of global economic health, increased volatility and an eight-year bull market worry investors?

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Macroeconomic headlines dominate in 2016

Macro and top-down events are dominating markets like never before in 2016. Rising uncertainty is to be expected when you combine the fact that we are eight years into the second longest bull market in history, in a US election year, and in an environment where so many of the pillars of past return are evolving. The result of the UK referendum on European Union (EU) membership has added to the list of macroeconomic and political risks facing markets.

On the other hand, those fearful of an aggressive US Federal Reserve tightening cycle may at least have their concerns allayed given rate increases are now likely to be more measured based on Brexit and global growth concerns. Regardless, macroeconomic concerns will persist in the near term, as investors put more weight on these issues rather than the underlying fundamentals of individual companies.

Earnings improvement presents opportunity

While the economic picture remains confusing for many, one comforting factor is that we continue to find numerous companies displaying better fundamentals, even in a modest-growth world. Although earnings have been poor at an aggregate level, there remain very interesting pockets of growth. We have identified many stocks that have earnings improvement potential in the next stage of the economic cycle.

Within the emerging world, there is still huge potential for change and market share gains in particular. Elsewhere, while the developed world growth outlook is subdued, building exposure to select contrarian and cyclical segments of the market, when the opportunity is afforded, can be a sensible approach in our view.

Valuations are reasonable but will not drive future returns

With global equities trading around 15-times 2017 earnings[1], the days of extremely cheap valuations are clearly over, but valuations remain reasonable in the context of the economic cycle and especially given alternative avenues for capital.

While valuations will not drive aggregate returns moving forward to the extent that they did in the early part of this equity cycle, at the same time, they should not be a barrier. Importantly, the lack of bullishness in the world has continued to keep broad-based bubbles at bay, and valuations have, therefore, remained at sensible levels.

The environment for equity investing, however, is more nuanced than in previous years. Investors have been cautious of stocks with cyclical characteristics through much of this equity cycle, while continuing to treasure stocks with defensive qualities and lower-volatility profiles. However, as markets have been shaken by growth concerns, a key opportunity has arisen: the chance to buy high-quality growth and improvement stocks on weakness.

Where do we go from here?

Challenging data points will continue to lie ahead for the global economy. However, further rate increases are now less likely, and monetary policy around the world remains generally accommodative. Bull markets usually end with a broad-based recession or due to valuation bubbles bursting—we see no signs of either.

Given these factors, we remain constructive, but market returns are likely to be more modest. While the outlook is more stock-specific and complex than it has been for some time, patient investors should continue to be rewarded over the long term.

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