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Global Equity Strategy

March 24, 2015

Sean Lynch, CFA®, Co-Head of Global Equity Strategy

Analysis and outlook for the equity market

  • Emerging-market (EM) equities rallied last week following relatively dovish comments from Federal Reserve (Fed) Chair Janet Yellen.
  • Yet we believe that EM equities are likely to experience both volatility and potential asset outflows once the Fed begins raising rates.

What it may mean for investors

  • We favor active management to capitalize upon the differences between EM countries. We believe that investors should maintain a targeted, neutral allocation to EM equities as part of a broadly-diversified portfolio.

Emerging Markets Heed the Fed's Call

Emerging markets rallied last week following relatively dovish comments from Fed Chair Janet Yellen. The belief that the Fed may not be in any hurry to raise interest rates was welcomed by equity investors in all areas, but none more so than EM investors. The memory of the EM equity downturn from nearly two years ago when Fed Chairman Ben Bernanke hinted that the Fed might taper asset purchases still lingers. EM sold off by 16.8 percent between May 9 and June 24 of 2013 following initial talk of tapering. This year, we have seen broadly mixed performance within EM countries. Yet on a year-to-date basis, the MSCI Emerging Markets Index is up 1.7 percent. We believe that EM stocks are in a better position to withstand a move by the Fed today than they were at that time. Yet concerns still remain.

Chart 1: Mixed Actions by EM Central Banks
 Chart 1: Mixed Actions by EM Central Banks
Source: Bloomberg, 3/23/15.

Central Banks Are Ready to Act

Currencies were a big part of the problem in 2013. Investors fled from EM equity and bond holdings. This, in turn, handcuffed many central banks from lowering rates to stimulate economies, just when they needed the help. Inflation worries were present at that time and also acted as a deterrent to stimulus. Today, the situation is different. EM currencies have not been immune to dollar strength but have fared better than developed-market (DM) currencies. Between June 30, 2014 and March 20, 2015, emerging-market currencies declined by 8.1 percent compared to an 18 percent decline for developed-market currencies.1 U.S. dollar strength has mostly impacted DM currencies like the euro and Japanese yen, and stemmed less from the Indian rupee and Chinese yuan. One additional factor giving central banks cover today is the absence of inflation in these markets. For some time, countries such as India and China have feared that domestic economic stimulus can stoke inflation. Today, with little inflationary pressures and more stable currencies, these economies appear to be in a much better position to withstand the spillover effects of any rate hike by the Fed.

Though EM economies may be on stronger footing, earnings continue to disappoint. The lack of improvement in corporate profitability can be blamed on inefficiencies in the corporate sector and government. Hope for corporate earnings improvement is consistently hung on reforms. We are seeing meaningful reform in some areas of the emerging world. Yet it may take some time for actions to translate into earnings, and challenges will be present along the way. The emerging-market indices sell at 11.6 times 2015 forward earnings, well below the price-earnings ratio of the S&P 500 and international developed markets. However, historically, EM equities have sold at a discount to those of the developed world. Nevertheless, we do not believe that EM equities will narrow this discount in the coming quarters.

Chart 2: Emerging-Market Price-Earnings Ratios vs. Those of Developed Markets: 2010 to Present
 Chart 2: Emerging-Market Price-Earnings Ratios vs. Those of Developed Markets: 2010 to Present
Source: Bloomberg, 3/23/15.

Investment Considerations

We believe that investors should maintain EM equity holdings at their targeted level. Our neutral rating reflects our belief that EM earnings will show some improvement in 2015 but not materially better than the developed world. We also remain wary of looming actions by the Fed. While EM equities may be in better shape today than they were in the spring and summer of 2013, we still believe that volatility and potential EM asset outflows could be experienced once the Fed begins to raise rates. In the coming months, policymakers in the emerging world will be communicating their preparedness for the Fed’s upcoming rate hike as they plan to stem outflows in EM equity and bond funds.

Lastly, this is one area in which active management may prove to be a benefit to investors. The emerging markets are comprised of vastly different countries and markets. Last week, China's equity markets rose every day on the back of stimulus plans. India has been one of the top performers with local markets appreciating 30 percent over the past year. Yet Brazil continues to struggle with dollar-based returns of -14.2 percent to date in 2015. Both volatility and performance variation are reasons to be nimble when assessing risks and opportunities within each emerging market. This is an advantage that we believe active managers can deliver to investors in 2015.

Weekly Wrap and Look Ahead

All major equity classes were positive for the week and year to date.

Index Last week's performance1 2015 YTD performance
S&P 500 +2.7% +2.4%
DJIA +2.1% +1.7%
NASDAQ +3.2% +6.1%
Russell 2000 +2.8% +5.1%
MSCI EAFE +1.9% +6.3%
MSCI Emerging Markets +3.2% +1.7%

1 For the week of March 16 – March 20, 2015
Source: Wells Fargo Investment Institute, Bloomberg, 3/23/15.

Four of 10 S&P 500 (the Index) sectors outperformed the Index while nine of 10 managed to gain ground for the week.

Best Performing Sectors Last week's performance2 Worst Performing Sectors Last week's performance2
Health Care +4.6% Materials -0.8%
Utilities +4.2% Telecom Services +1.6%
Energy +3.4% Financials +1.8%

2For the week of March 16 – March 20, 2015.
Source: Wells Fargo Investment Institute, Bloomberg, 3/23/15.

The major indices rallied toward record highs late last week as Fed Chairwoman Janet Yellen appeared to clarify that the U.S. central bank was not on the brink of raising interest rates. The consensus timetable for the initial rate hike was moved out toward the September FOMC (Federal Open Market Committee) meeting. Equity traders embraced that possibility, and stocks finished the week on a high note.

This week's economic calendar features data covering housing, consumer inflation, business capital spending and consumer sentiment. We will be paying the closest attention to the "non-defense orders for capital goods excluding aircraft" segment of Wednesday’s February durable-goods report. This segment is volatile, but is a good indicator of business capital spending. Business spending on capital goods has been slow in this recovery when compared to past cycles. Our work suggests that capital spending will increase as we move through 2015.

The reports covering housing and consumer inflation are unlikely to have much of an effect on equity markets unless the results are far from consensus. Most market participants see very little inflationary pressure over the coming year. We concur with this assessment as our projection for the 2015 increase in the Consumer Price Index (CPI) is 1.4 percent. In addition, we expect that the housing market will continue to move ahead at a slow pace. Like most other areas of the domestic economy, modest improvement is all that can be expected at this point. History shows that stocks can do well in a modest growth/modest inflation environment like the one we foresee for 2015.

Sector S&P Weighting* Wells Fargo Investment Institute Guidance
Consumer Discretionary 12.6% Overweight 13.4%
Consumer Staples 9.6% Underweight 8.5%
Energy 7.8% Neutral 8.0%
Financials 16.2% Neutral 16.5%
Health Care 15.1% Neutral 14.8%
Industrials 10.4% Overweight 11.6%
Information Technology 19.9% Overweight 21.8%
Materials 3.1% Neutral 3.0%
Telecom Services 2.3% Neutral 2.4%
Utilities 3.0% Underweight 0.0%
S&P 500 earnings estimate for 2015 $128.00
S&P 500 year-end 2015 target range 2,150-2,250

*Sector weightings may not add to 100% due to rounding. Weightings as of 3/20/15 close.
Source: Wells Fargo Investment Institute, Bloomberg, 3/23/15.

1 Emerging-market currencies were measured through the Wells Fargo Investment Institute (WFII) Emerging Markets Currency Index. This proprietary index tracks currency changes of the 15 largest emerging-market trading partners for the U.S. dollar. Each country’s index weight is determined by the relative share of goods-trade conducted with the United States. Developed-market currencies were measured through the WFII Developed Markets Currency Index. This proprietary index tracks the currency changes of the 11 largest developed-market trading partners for the U.S. dollar. Each country's index weight is determined by the relative share of goods-trade conducted with the United States.

Sean LynchAbout Sean Lynch

Sean Lynch is the co-head of global equity strategy for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.

In his current role, Mr. Lynch is responsible for developing global equity strategy and oversees proprietary equity strategies as well as the equity trading desk. He has represented Wells Fargo to the media on numerous occasions, providing insights and perspectives on the global markets. He has also written extensively about global issues and the implications on client portfolios, appearing in Bloomberg, The Wall Street Journal, USA Today, Money, and on CNBC.

Mr. Lynch has been with Wells Fargo for 17 years. Prior to his current role, he served as a global investment strategist for Wells Fargo Private Bank. He has traveled extensively internationally—from Asia to South America to Europe—to gather firsthand knowledge and information, and has shared his observations and perspectives with clients and team members. He has been in the investment management and trust industry for 24 years.

Mr. Lynch earned a Bachelor of Science in Business Administration, specializing in Accounting and Finance, from the University of Nebraska-Omaha. He is a CFA® charterholder and a former president of the Omaha-Lincoln Society of Financial Analysts. Mr. Lynch is located in Omaha, Nebraska.

*As of Sept. 30, 2014

Risk Factors

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

An index is unmanaged and not available for direct investment.

S&P 500 Index is a capitalization-weighted index calculated on a total return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies.

Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.

NASDAQ Composite Index (Symbol: COMP) includes all domestic and international based common type stocks listed on The NASDAQ Stock Market. The NASDAQ Composite Index is a broad based Index.

Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 8 percent of the total market capitalization of that index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

MSCI EAFE® Index (Europe, Australasia, Far East) is an unmanaged group of securities widely regarded by investors to be representations of the stock markets of Europe, Australasia and the Far East.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.


Global Investment Strategy ("GIS") is a division of Wells Fargo Investment Institute, Inc. ("WFII"). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the GIS division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including you existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

Brokerage products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is the trade name use by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company.