Global Perspectives

A weekly analysis of timely economic strategy issues from Wells Fargo Investment Institute.

November 14, 2017

Veronica Willis, Investment Strategy Analyst

Investor Confidence Signals Improvement Overseas

Key Takeaways

  • Investor and consumer confidence in Europe and Asia historically have moved together. Yet, this relationship broke down in 2015 as investors worried that developments in China, falling commodity prices, and other factors could lead to a sharp global economic slowdown, while consumers looked past these concerns.
  • In recent months, investor confidence has stabilized in Europe and is showing signs of improvement in Asia. We expect this trend to continue as buoyant business and consumer sentiment continue to support economic and earnings fundamentals.

What It May Mean for Investors

  • International equities have outperformed U.S. equities due to improved economic conditions and earnings growth, along with a weaker dollar. We believe that international equities may continue to outperform U.S. stocks, but we expect widening rate differentials to weigh on international developed fixed-income performance.

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Investor and consumer sentiment historically have tracked together—as these indicators typically have a similar focus: economic growth, labor- and housing-market health, and financial-market conditions. In a previous report, we discussed the divergence of U.S. investor confidence from consumer sentiment.1 Today’s report discusses the relationship between investor confidence and consumer sentiment internationally, especially in Europe and Asia, and highlights investment opportunities associated with stabilizing and improving investor confidence.

Investor and Consumer Confidence Divergence

As in the U.S., investor and consumer sentiment in Europe and Asia have diverged in recent years. This began with an investor-confidence dip in 2015, while consumer confidence remained more stable. Concerns over global economic growth—led by a slowdown in Chinese growth, falling commodity prices, and persistent dollar strength— all detracted from investors’ willingness to invest. This contributed to a broad sell-off in global risk assets.

We believe that investor confidence tends to align most with future economic and financial-market expectations— while consumers concern themselves more with their local economy and personal circumstances when making spending decisions. While consumers and investors are both focused on the state of housing, labor and financial markets, consumers are still willing to spend when current conditions are good, but investors often look into the future as they assess their market view. Additionally, investors may focus on a more global picture concerning their investments.

Investor Confidence Overseas Is Showing Signs of Improvement

Today, investor confidence in Europe and Asia is on the mend, and for good reason. The Eurozone economy is growing at a pace not seen since 2011. As the European economy strengthens, led by the Eurozone, consumer expectations have improved this year. Business confidence also has been improving in the Eurozone since mid-2016. Despite the surge in consumer and business confidence, investor confidence has lagged. Investor confidence peaked in late 2014 and started to decline amid concerns over weak global economic growth. European investor confidence has stabilized over the past year but has not yet started to improve.

Chart 1. Business Confidence in Europe Has Been ImprovingBusiness Confidence in Europe Has Been ImprovingSources: Bloomberg, Markit. 11/1/17. PMI = purchasing managers’ index.

The State Street Investor Confidence indices track the composition of institutional investment portfolios and measure the changes in risky-asset holdings. Investor confidence should increase as the level (of these assets) held rises.

Chart 2. European Investor Confidence Has StabilizedEuropean Investor Confidence Has StabilizedSources: Bloomberg, European Commission, State Street. 11/1/2017.

We believe that the European economy will continue to grow—supported by improving consumer spending and accommodative monetary policy. Additionally, we expect that continued economic improvement, along with strengthening future-growth expectations, should lead to continued gains in investor confidence going forward. A similar trend has developed in Asia. Prior to 2015, Asian investor and consumer confidence moved in line with one another. Similar to other regions, investor confidence has declined, while consumer confidence has strengthened. Economic growth in Japan and China has been bolstered by improving global-trade activity, but investors may be looking for more evidence in order to commit more funds to risk assets. In a change from the past, investors now seem to require more sustained periods of economic growth (and improving consumer confidence) before shifting their investing behavior to reflect more confidence in financial markets.

Chart 3. Asian Investor Confidence Shows Early Signs of ImprovementAsian Investor Confidence Shows Early Signs of ImprovementSource: Bloomberg, Organisation for Economic Co-operation and Development (OECD). 11/1/17. *The OECD defines the five major Asian countries as China, India, Indonesia, Japan and South Korea.

Investment Implications

Global consumer confidence has benefited from improvements in the global economy and financial-market conditions. International equities have outperformed U.S. equities this year—led by improved economic conditions in these regions and better-than-expected earnings growth. With that said, while investors have been testing the financial-market waters this year, their confidence has notably lagged the rebound in consumer sentiment. We believe that investors may need to see signs of sustained improvement in international earnings and economic conditions to become more engaged (and confident) in the related market rallies.

Looking forward, we believe that international equity markets could be poised for appreciation, should investor confidence in Europe and Asia follow a similar trend to that in the United States. International economies are at an earlier point in their economic cycle than the U.S. is, signaling that there is still time for investor confidence to improve. While we remain evenweight developed- and emerging-market equities, we prefer international equities over domestic equities for new allocations. Within developed-market equities, we favor the Pacific region, based on our expectations for future economic growth, improved manufacturing activity, and global-trade prospects.

Chart 4. International Equities Have Outperformed This YearInternational Equities Have Outperformed This YearSource: Bloomberg. 11/10/17. Past performance is no guarantee of future results.

Despite this year’s positive performance in unhedged international developed-market (DM) fixed income due to a weaker dollar, we expect widening rate differentials and low yields to remain headwinds for international DM-debt investors. Many major DM bond yields remain low relative to U.S. Treasury securities. In addition, our outlook for the U.S. dollar calls for moderation against the euro and yen through 2018, which could hurt international DM fixed-income performance. We recommend that investors remain broadly and globally diversified in fixed income, and we continue to recommend an underweight position in DM fixed income.

Economic Calendar This chart lists the upcoming economic reporting estimates.Source: Bloomberg as of 11/10/17.

1 Global Perspectives, “What Are Consumer and Investor Confidence Signaling?”, September 19, 2017.

Risk Considerations

Forecasts are not guaranteed and are subject to change.

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. Small- and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks. Bonds are subject to market, interest rate, price, credit/default, liquidity, inflation and other risks. Prices tend to be inversely affected by changes in interest rates. High yield (junk) bonds have lower credit ratings and are subject to greater risk of default and greater principal risk. Diversification does not guarantee profit or protect against loss in declining markets.

Definitions

The European Commission EU Consumer Confidence Index tracks sentiment among households or consumers. The results are based on surveys conducted among a random sample of households.

State Street European Investor Confidence Index is an index that measures investor confidence for European institutional investors by looking at actual levels of risk taken by investors in their portfolios.

Organization for Economic Co-operation and Development (OECD) Major 5 Asia Consumer Opinion Confidence Index is a consumer opinion survey conducted by the OECD to gather information on consumer expectations in China, India, Indonesia, Japan and South Korea.

State Street Asian Investor Confidence Index is an index that measures investor confidence for Asian institutional investors by looking at actual levels of risk taken by investors in their portfolios.

The Markit Eurozone PMI Composite Output Index tracks business trends across both the manufacturing and service sectors, based on data collected from a representative panel of over 5,000 companies. The index tracks variables such as sales, new orders, employment, inventories and prices.

The Markit European Union PMI Composite Output Index tracks business trends across both the manufacturing and service sectors, based on data collected from a representative panel of over 5,000 companies. The index tracks variables such as sales, new orders, employment, inventories and prices.

S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value.

MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. It is unmanaged and unavailable for investment.

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

An index is unmanaged and not available for direct investment.

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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