Just how bad is it internationally? There is a strong current of negative news that continues to flow out of Europe and emerging markets. We are bombarded with attention grabbing articles and negative headlines that paint a dark picture overseas. Headlines such as “Global ransomware attack causes turmoil” and “U.S. downgrades China over trafficking” are just two of the headlines found on BBC’s website recently.
In Europe, coverage focuses on Brexit (United Kingdom withdrawing from the European Union), the increasing number of terrorist attacks, the rise of populism, and the unraveling of the European Union. While in emerging markets, China’s economic slowdown, political corruption in Brazil, corporate scandals in South Korea, and Mexico’s border wall dominate the headlines.
Despite the flurry of negative news and headlines, European and emerging market stocks are two of the strongest performers year-to-date. How can that be? What is driving the strong performance?
Emerging Markets
Emerging market equities returned 18.6% year-to-date. Over the past several quarters, many headwinds for emerging markets have abated. Emerging market currencies have strengthened, uncertainty around China's economic growth has diminished, and the US Dollar has weakened. Relative to the United States’ mature economic recovery, many emerging countries are beginning to pull out of a recession and starting to enjoy a growth rebound. In 2014, the phrase “Fragile Five” was coined to describe five emerging market countries (Turkey, Brazil, India, South Africa, and Indonesia) that amassed incredible amounts of foreign debt. These countries were vulnerable to defaulting and had the capital markets worried. Fast forward three years later, these countries have meaningfully reduced their current account deficits and strengthened their balance sheets. With many of the headwinds dissipating, investors are again excited about the potential in earnings growth, higher economic growth, and positive demographic trends available in emerging markets. Companies are benefiting from the improved global conditions and it is showing up in earnings. Between 2011-2015, earnings growth was negative, which had a lot to do with falling commodity prices and a strong U.S dollar. Contrast that to this year where emerging market companies have seen an earnings growth of 8-10%. This story is still developing, but we remain cautiously optimistic in emerging markets.
Europe
European markets had a strong first half of the year, returning 15.36% year-to-date. Europe fell into a deep recession after the 2009 European debt crisis. Unlike the Federal Reserve Bank, the European Central Bank (ECB) was slow to react and provided monetary stimulus years after the recession began. Europe is starting to benefit from this as the ECB continues to support the economy. Tides appear to be shifting and things are looking up – manufacturing data has reached multi-year highs, business optimism is strong, and employment is improving. Political risks have largely been avoided, but the story is evolving with Italian and German elections set to take place later this year. When Brexit shocked the world, many feared other countries would follow, leading to the European Union’s demise. There was too much uncertainty and too many unknowns for investors to confidently deploy capital in the region. Investors breathed a sigh of relief after Dutch and French elections resulted in pro-European Union officials. Post-election, markets bounced back from depressed levels and investors started to focus on the positive fundamentals and encouraging economic data.
Conclusion
Sensationalized news stories can distract us from what really matters, which are earnings, economic outlook, and valuations. What gets lost in the news cycle are the positive developments occurring overseas. On the economic front, we are in the midst of a rare, synchronized, global economic expansion. Earnings are rebounding and valuations for both Europe and emerging markets remain attractive relative to the U.S.
In short, it is a risky game to invest based on headlines. Negative news does not equate to poor stock returns and vice versa.