Tyler Mordy, president and CIO at Forstrong Global Asset Management
Focus: ETFs

MARKET OUTLOOK

U.S. equity valuations have become stretched, trading at a 33.6 per cent premium to the remainder of the global benchmark on a price-to-book basis and some 113 per cent on a forward price-to-earnings basis. Even though the U.S. share of global GDP declined from 32 per cent in 2001 to only 23 per cent recently, its share values nevertheless now command 63.7 per cent of the MSCI World market capitalization. U.S. stocks are priced for near perfection.

Cracks have been spreading for some time in the U.S. outperformance story, with deeper fundamental change afoot.  America’s waning global leadership has diminished its attractiveness. Trump’s betrayal of the post-war system and his Twitter rants took a proverbial wrecking ball to long-standing alliances. In an increasingly interconnected world, the biggest loser has been the U.S.

A more immediate dynamic is underway.  Several constraints limit the U.S.’s policy flexibility to counter slowing growth. The country is already well into a kind of monetary dark age, with limited room to stimulate. Jay Powell, despite his newfound savoir-faire, has acknowledged the Fed’s constraints. Like his counterparts in Europe, Powell has emphasized the importance of fiscal expansion to share the policy burden.

On the fiscal side, limitations also exist. Corporate tax cuts led to a material one-off advantage for U.S. earnings, but don’t provide a sustainable boost to longer-term growth. Now, the government is running a sizable fiscal deficit, the economy has a substantial current account deficit and further fiscal stimulus is unlikely with a split Congress.

Now consider the global contrasts. Policy options are far more plentiful in other countries outside the U.S. In South Korea, Japan and Poland, significant fiscal expansion has been announced. In Brazil and India, structural reform is swiftly underway. In China, regulatory changes are rapidly opening the financial sector. And rate-cutting cycles have begun in Russia and Indonesia.

Here are a set of countries outside the U.S. with more policy levers than growth headwinds. This remains their ace in the hole. Policymakers in these countries are far less concerned about a sudden growth downturn than the common narrative would lead one to believe.

All this is now showing up in the growth profiles of these countries, leading to better earnings-driven stories. Combined with far more attractive valuations, capital should continue to move away from the U.S. into these regions.  

TOP PICKS

ISHARES MSCI SOUTH KOREA CAPPED ETF (EWY:UN)
Last purchased on June 17 at US$56.88.

With deep integration into global supply chains, South Korean hardware exports have faced the brunt of the U.S.-China trade war. Although the market traditionally carries a “Korea discount” due to the cross-ownership chaebol structure, external weakness has driven stocks to historically cheap valuations.

A phase 1 China-U.S. deal signals an easing in tensions. Already semiconductor sales appear to have formed a bottom. Additionally, Seoul recently announced its largest fiscal stimulus plan since the Financial Crisis and the Bank of Korea cut interest rates in July and October, providing a more accommodative monetary backdrop. The upside leverage to stabilizing global growth and trade detente is enormous.

ISHARES MSCI EUROPE FINANCIALS ETF (EUFN:UW)
Last purchased on June 17 at US$17.66.

European financials are a consensus underweight amongst global asset managers. In addition to headline risks in Europe including ongoing Brexit turmoil and the flailing German manufacturing sector, financials have also had to contend with negative rates on excess reserves as well as numerous serious fines and sanctions. Basel 4 regulations (to be implemented between 2022-2027) will threaten capital adequacy and constrain future lending. However, with a dividend yield over 5 per cent and the sector trading below book value, we believe that these risks and challenges are well priced in. With the ECB now implementing a tiered deposit rate system, pressure on governments to pursue fiscal stimulus and global growth supported by a renewed monetary easing cycle, European financials make for a deep value pick with considerable upside potential.

ISHARES MSCI CHILE ETF (ECH:UN)
Last purchased on Dec. 16 at US$34.14.

Chilean assets have sold off heavily of late, as a socio-political uprising rocked the nation known for stability in a generally tumultuous part of the world. The unrest is unlikely to abate quickly, as Chile has a high degree of income inequality and an underwhelming social safety net. The nation’s relatively low corporate tax rate will likely come under increasing scrutiny. However, an agreement between protesters and the government to schedule a constitutional referendum in April 2020 should help calm tensions on the ground for the time being. The sell-off has left Chilean stocks trading at very attractive valuations, diverging from tight historical correlations to industrial commodity prices such as copper, which appear to be stabilizing alongside global trade volumes. Chile’s public debt is among the lowest in the world and thus they have much room to fiscally stimulate.

PAST PICKS: MAY 13, 2019

XTRACKERS HARVEST CSI 300 CHINA A-SHARES ETF (ASHR:UW)

• Then: $25.66
• Now: $29.39
• Return: 15%
• Total return: 15%

VANECK VECTORS VIETNAM ETF (VNM:UN)

• Then: $16.14
• Now: $15.88
• Return: -2%
• Total return: -2%

ISHARES MSCI SOUTH KOREA ETF (EWY:UN)

• Then: $55.61
• Now: $61.37
• Return: 10%
• Total return: 13%

Total return average: 9%

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TWITTER: @tylermordy
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