International Strategy

Timely commentary from Wells Fargo Investment Institute on international topics in the news.

February 1, 2018

Peter Donisanu, Investment Strategy Analyst

Regional Guidance Update: Fundamentals Still Improving

  • International economic and equity market fundamentals have broadly improved over the past 12 months.
  • These improvements have underpinned our standing regional guidance on developed markets and have contributed to upgrades in some emerging-market regions.

What it may mean for investors

  • We believe that international investment fundamental improvements are likely to continue in 2018, broadly supporting international equity market exposure in investment portfolios.

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International economic growth notably accelerated last year. For the first time since the height of the Global Financial Crisis, the world economy exhibited a synchronized expansion. As a result, global equity markets rallied to varying degrees, having benefited from rising market participant sentiment as the economic recovery translated into a corporate earnings recovery. Below, we provide a brief summary of our regional equity market guidance.

Chart 1. International fundamentals notably improved in 2017Chart 1. International fundamentals notably improved in 2017Sources: Wells Fargo Investment Institute, Bloomberg, January 26, 2018. Past performance is no guarantee of future results.

These improvements have underpinned our standing guidance in developed markets and have also contributed to upgrades in the Latin America and emerging-market (EM) Europe, Middle East and Africa (EMEA) regions we cover. Stretched valuations and less- than-favorable market internals have underpinned our neutral guidance in Europe and EM Asia, while improving economic, valuation, and market internals continue to support our favorable rating on the Pacific region. In general, we believe that the virtuous economic trend underpinning fundamental improvements is likely to continue in 2018, broadly supporting international equity market exposure in investment portfolios.

Developed Market Ex.-U.S. Equities

Europe Region (Neutral Rating). We have maintained a neutral rating on European equities. Our conviction on the region has moved higher in recent months on improving economic fundamentals, yet fair valuations and moderating market internals continue to support our current neutral guidance.

  • Economic: Broad economic-activity measures have trended higher for France, the Netherlands, and Germany. The U.K. and Switzerland are facing soft economic conditions relative to long-term averages.
  • Market Valuations: Rising earnings growth has helped to keep rich valuations in check as prices have increased. Yet, with the exception of Spain and the U.K., we believe European valuations are fairly priced relative to three-year averages.
  • Market Internals: The European-stock rally has narrowed, and price movement has been driven by lower volumes, suggesting a bearish European market outlook. This negative view is corroborated by our technical analysis, which is largely bearish on U.K. equities.

Pacific Region (Favorable Rating). Our favorable Pacific-region rating remains unchanged, even as it has come under increased scrutiny in recent months. Near- and longer-term economic trends and market internals are positively biased, while valuations have become stretched recently.

  • Economic: Measures of long-term economic trends suggest positive activity in Japan, Australia, Singapore, and Hong Kong. Surprises (a measure of actual releases beating consensus expectations) have increased, most notably in Japan. This trend continues to strengthen.
  • Market Valuations: Valuations are fairly priced. Stock prices have recently caught up to rising earnings growth, making stocks relatively more expensive in recent months. While multiples recently have crept modestly higher, they remain in line with levels 12-18 months ago, given positive earnings-growth momentum.
  • Market Internals: Internals suggest stable market conditions after weakening sharply in the fourth quarter of 2017. Fund flows and sentiment reflect bullish market conditions. Prices moving higher on narrow volumes are a negative indicator for market internals. Longer-term technical work supports upward price momentum in Pacific-region stocks (in Japan and Hong Kong, particularly) relative to the broad stock benchmark.

Emerging Market Equities

Emerging Asia (Neutral Rating). Valuations have moderated after a modest pullback in the EM Asia regional index in December. Improvements in regional economic and earnings fundamentals remain intact, while market internals and technical work reflect a generally balanced outlook.

  • Economic: Long-term economic trends are stronger across the region, notably in China. A mix of positive and negative economic surprises, coupled with a more neutral bias in China’s long-term growth momentum, suggests that economic growth momentum, while positive, may be leveling off.
  • Market Valuations: We believe equity markets in Emerging Asia are fair-to-attractively priced following December’s equity market sell-off and rising corporate earnings. We expect a regional earnings recovery to support more favorable valuations, but we view the region as fairly valued. Yet, elevated prices in the technology-sensitive regional index make the region’s stocks susceptible to pullbacks in the coming year.
  • Market Internals: Fund flows are positive market internal indicators, while moving-average, breadth, volume, and sentiment are balanced. Market technicals support our current regional rating.

Emerging Europe, Middle East and Africa (EMEA) Region (Neutral Rating). Improvement in the EMEA region’s economic, earnings, and market environment continue to underpin our neutral rating. We expect that ongoing geopolitical concerns and commodity-price volatility may challenge investment sentiment in the region. Nevertheless, we believe that these negative expectations are balanced against a firming fundamental environment.

  • Economic: Strengthening growth trends, and higher incidences of positive data-release surprises, recently have characterized the generally improving regional economic environment. We believe that this trend will persist into the coming year.
  • Market Valuations: Valuations appear balanced across the region. Equity markets have rallied strongly year to date, pushing prices to multi-year highs. Nevertheless, earnings growth accelerated in 2017, balancing out price gains from a valuation perspective.
  • Market Internals: Data reflect a negatively biased outlook for market-price conditions. Market-internal indicators are generally negative, and fund flows have trended toward unfavorable conditions. Technicals reflect an unfavorable rating when measured against the broader emerging-market benchmark over a longer time period.

Latin America Region (Neutral Rating). Improving valuations, economic fundamentals, and market internals supported our January upgrade of Latin American equities from unfavorable to neutral. We continue to monitor equity market moves in Latin America, particularly in Brazil, as prices have historically had the tendency to outrun valuations.

  • Economic: Measures of long-term activity suggest that Brazil’s economy is poised for its first yearly gain since 2013. Long-term economic activity measures in Mexico are positively biased despite pressures from trade-policy uncertainties and a weaker peso.
  • Market Valuations: Latin American equities are fairly valued after having corrected during the fourth quarter of 2017. Valuations for Brazilian and Mexican stocks have trended toward the fairly valued levels, while Chilean stocks appear expensive relative to three-year averages.
  • Market Internals: Positive measures of breadth and market sentiment underpin favorable market internals. Long-term technicals suggest Latin American equities may continue to face headwinds in the coming months.

Risk Considerations

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets.

Definitions

An index is unmanaged and not available for direct investment.

Wells Fargo Investment Institute (WFII) Developed Market Economic Diffusion Index is a composite measure of changes in 19 Developed Market countries' key economic metrics relative to a five-year rolling lookback period. Metrics tracked include labor and productivity, trade, inflation, monetary conditions and consumer spending. A score above zero represents expansion; a score below zero represents contraction.

Wells Fargo Investment Institute (WFII) Emerging Market Economic Diffusion Index is a composite measure of changes in 16 Emerging Market countries' key economic metrics relative to a five-year rolling lookback period. Metrics tracked include labor and productivity, trade, inflation, monetary conditions and consumer spending. A score above zero represents expansion; a score below zero represents contraction.

MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of 21 developed markets, excluding the U.S. and Canada.

MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of 23 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 Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information 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.

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