Europe, Emerging Markets Race To The Front Of The Pack

6/19/2017


The first half of 2017 has seen investors gravitate toward geographic markets they largely avoided over the past decade, reflecting signs of continued economic improvement.

The MSCI European Union Index, down an annualized rate of 3% over the past decade, has rallied 14% in 2017. Economists have become more bullish on the euro zone's growth prospects since the beginning of the year. Spurred by strong retail sales and higher investment spending, the euro zone's economy expanded in the March quarter at its fastest rate since the first three months of 2015.

Even weaker members of the euro zone participated in the growth, which could embolden officials to ease up on stimulus measures. Although the region continues to experience weak inflation, its jobless rate fell to a seven-year low in May. The euro zone contains countries in the European Union that use the euro as their national currency.

Emerging strength

After trading virtually sideways for the past decade, the MSCI Emerging Markets Index has surged 17% in 2017. China, up 23%, and India, up 21%, are helping to drive those gains. Although China's GDP growth is projected to slow in both 2017 and 2018, estimates have ticked higher in recent months. India's GDP growth is expected to accelerate to 7.2% this year and 7.7% in 2018, according to Blue Chip Economic Indicators.

Meanwhile, the U.S. keeps chugging along. On June 14, the Federal Reserve raised interest rates for the second time this year and fourth time since the financial crisis. The Fed has signaled plans for three rate increases this year. About one-third of economists anticipate the third hike occurring in December, based on a survey by The Wall Street Journal.

Like Europe, the U.S. is experiencing an upbeat labor market but weak inflation. Lawmakers' plans to cut taxes and boost infrastructure spending would further stimulate the U.S. economy — and potentially require more aggressive actions from the Fed. But it's still not clear whether Congress is willing or able to enact those proposals.

Stocks performing well

Up 10% in 2017, the S&P 500 Index is on pace to post its ninth straight year of gains. That extended run makes U.S. stock valuations look elevated. S&P 500 Index stocks average P/E ratios of 21.2 based on estimated current-year profits, well above their average of 18.0 since 2005. In just one of the past 150 month-end periods has the index's forward P/E ratio been higher.

Growth expectations are optimistic. The S&P 500 Index is projected to grow earnings per share 12% this year, which would mark the strongest annual growth since 2010, according to Thomson Reuters. Better yet, analyst estimates are holding up unusually well for this time of year.

While high U.S. stock valuations merit concern, they should not be viewed in a vacuum. Of course, investors could very well be overpaying for profit growth that fails to materialize. But the stability in analyst estimates is a bullish sign that expectations remain reasonable and that stocks
may still have room to build on their gains. 

Increasingly bullish economic expectations . . .
Consensus targets for 2017 economic growth have slipped in the U.S. since January, but estimates for other key geographic markets have risen.
------------------------- Growth In Gross Domestic Product (GDP) -------------------------
----- Estimated 2017 -----
----- Estimated 2018 -----
2015 (%)
2016 (%)
January (%)
Current (%)
January (%)
Current (%)
United States
2.6
1.6
2.3
2.1
2.4
2.4
Euro zone
1.9
1.7
1.5
1.7
1.6
1.6
China
6.9
6.7
6.4
6.6
6.0
6.1
India
7.6
6.9
7.1
7.2
7.7
7.7
Japan
1.2
1.0
1.0
1.3
0.7
0.9
Source: Blue Chip Economic Indicators.
. . . drive robust stock returns
Rising optimism about economic growth has lifted stocks, particularly in the European Union and emerging markets.
----------------------------- Price Returns -----------------------------
MSCI Index
Year-To-Date
(%)
5 Years
(Annualized)
(%)
10 Years
(Annualized)
(%)
United States
9
13
5
European Union
14
7
(3)
China
23
6
2
India 
21
8
2
Japan
10
9
0
Developed world
10
10
2
Emerging markets
17
2
(1)
Source: MSCI.

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