Mike Pyle, Global Chief Investment Strategist, together with Elga Bartsch, Head of Marco Research, Scott Thiel, Chief Fixed Income Strategist, and Beata Harasim, Senior Investment Strategist, all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
As economies start to normalize, we see European equities as the most attractive regional exposure to a differentiated global reopening. The region sports a robust health infrastructure, exposure to a pickup in global growth, and galvanized policy response with room for more stimulus. As a result, we see it offering better risk-reward than traditional beneficiaries of a growth pickup: emerging markets (EMs).
The pace of the activity restart depends on how successful countries are in suppressing the virus as they reopen. This gives Europe a leg up versus much of the emerging world. Many EM countries have less robust public health systems, and the pandemic has not yet peaked. Infections have jumped in Latin America after an initial lag, as the chart shows, and are steadily rising in emerging Europe, Middle East and Africa (EMEA), and South Asia. By contrast, infections in developed Europe have been on a downward trajectory since peaking in April.
To be sure, EMs are heterogenous. The virus outbreak – and ability to withstand it – varies greatly by country. Many north Asian economies, for example, appear to have gained control of the epidemic – and have relatively strong balance sheets and the policy space to weather the downturn.
Europe’s health capabilities and containment measures position the region well for a domestic recovery. European companies also are highly geared to an improvement in global trade and recovering Chinese economy. Some EM economies are likely to benefit, too, and tech-focused Asian countries are showing early signs of a pickup in trade. Escalating U.S.-China trade tensions are a risk to market sentiment toward EM, European and Japanese equities alike in that respect. Europe, however, is less vulnerable to any renewed downturn in commodity prices than EM economies that are heavily exposed to commodities and natural resources, such as Russia and Brazil.
Importantly, the monetary and fiscal support to cushion the virus shock is stronger in Europe than in EM countries and Japan - and there is space and appetite for additional stimulus. After an initially slow start, the euro area has galvanized its policy response. The European Central Bank has made clear that it stands ready to add more monetary stimulus. Leaders of the 27 EU member states last week discussed a groundbreaking, joint economic recovery package at their first physical summit since the start of the coronavirus lockdown. Importantly, unprecedented coordination between fiscal and monetary authorities is allowing the region to unleash stimulus and bring down peripheral borrowing costs at the same time. By contrast, we see the policy space in many EM countries as much more limited, as many risk spiking interest rates and sliding currencies in response to more fiscal or monetary stimulus.
What are the risks in preferring Europe over EM? First, a surprise in the pandemic’s trajectory. This could range from a drop in EM infection rates to a virus resurgence in Europe. Second, EM equities could further outperform European peers if the U.S. dollar weakens against EM currencies or if the global growth upswing is much larger than we expect.
Bottom line: We are overweight European stocks due to the region’s strong public health systems and ramped-up policy response. We are underweight EM equities outside North Asia due to the pandemic’s spread and limited policy space. North Asia has the virus under control for now and has the capacity for more stimulus, keeping us neutral on both Japanese and Asia ex-Japan equities. We like U.S. equities for their quality bias, but the risk of fading fiscal stimulus and election uncertainty keep us neutral.
Measures to contain the virus are being gradually eased in many developed economies, and lifted activity and employment in June. The unprecedented policy response has boosted risk assets, leaving the U.S. resurgence of infections in Sunbelt states and the possibility of fading fiscal stimulus as key market risks. U.S. Congress is headed for a fiscal cliff as additional jobless benefits and small business support are set to expire, and states face huge budget shortfalls. We could see a $1-1.5 trillion fiscal package that extends some (but not all) federal stimulus measures through late-2020.
A slew of early estimates of Purchasing Managers’ Indexes (PMIs) will be in focus to gauge business sentiment as economies show signs of rebounding. Activity normalization may take time, and the key will be restarting economies without restarting a virus outbreak. We track the interplay between virus outbreaks and mobility changes as a signpost for the pace of activity restarts around the world.
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