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Global Equities: What is Driving Regional Returns Dispersion?

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June 23, 2021—Over the last three months, global equity share prices have risen, validating our pro-cyclical equity positioning. It is worth noting that within global equities, we have seen a massive dispersion of return performance across regions/countries (see the chart below comparing trailing three-month return performance for various regional exchange traded funds (ETFs) and their larger component stocks). This Wilmington Wire explains the drivers of such large dispersion and identifies what we are looking for as signposts for closure of such performance gaps.

At one extreme, Chinese equity prices have sharply declined, due largely to the continuing antitrust investigations and actions being taken by the authorities against e‑commerce and internet platforms, such as Alibaba and Tencent. Collectively, these platforms comprise about 40% of the China index. The antitrust measures have had a more protracted and adverse impact than stock analysts had anticipated three months ago. While outright dismantling of firms is not on the table and fines have been comparatively small, investigations are continuing. We believe that these stocks are now attractively valued and that their share prices may surge once the regulatory environment becomes more stabilized.    

Global equities

3-month trailing U.S. Dollar (USD) returns through June 21, 2021

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Source: Bloomberg. Data as of June 21, 2021.

Investing involves risks and you may incur a profit or a loss. Past performance cannot guarantee future results. There is no assurance that any investment strategy will be successful.

The principal Asian semiconductor manufacturers—Taiwan Semiconductor and Samsung Electronics—should be generating sizable profits due to surging global demand and higher semiconductor prices. However, these firms have struggled to produce sufficient chips to alleviate global shortages. Both have had to confront COVID outbreaks and restrictions. Taiwan Semiconductor has faced droughts and fires affecting their water supply (clean water is an essential component in the chip manufacturing process). These constraints on output are temporary, but surging global demand is not. We anticipate that these stocks should recover sharply on the strength of higher semiconductor prices and earnings expectations.

At the other extreme, the Brazilian, Russian, and Canadian currencies, and their local equity markets, have soared on the strength of surging crude oil and metals prices, producing outsized USD returns. For example, in Brazil, higher oil and metals prices have bolstered the local share prices of state energy company Petrobras and certain mining companies, most notably, Vale. Within emerging markets (EM), the positive contributions of Brazil, Russia, and South Africa to EM returns have only partially offset those of China, because those markets, even combined, constitute a much smaller share of the EM index than China. Commodity-linked EM equity markets typically exhibit extreme performance cycles, so one can reasonably anticipate a sharp reversal, especially if/when commodity prices stabilize or slip, or if there is a political-risk event in one of these markets.

Eurozone equities have significantly outperformed U.S. equities, while UK equities have only slightly underperformed. One reason for the higher eurozone returns is a strengthening of the Euro (EUR) against the USD. Investors are anticipating strong European recovery given that the continent is emerging from COVID lockdowns and also given unprecedented actions by the EU and European Central Bank to deliver substantial COVID-related recovery assistance. Eurozone equities are less weighted to growth stocks and are more highly leveraged than U.S. equities to cyclical economic recovery. As for the UK, while some stocks are struggling with the consequences of Brexit, the commodity price rally has bolstered both the Pound (GBP) and the UK-domiciled global energy and metals stocks.

Finally, Japanese equities, in USD terms, have performed relatively poorly against the U.S., the eurozone, and the UK. In part, this is due to the Japanese local public health authorities lagging behind the U.S. and Europe in terms of COVID recovery. It is also due, in part, to Japanese firms’ reliance on the Chinese market, which has slowed somewhat. But perhaps most importantly, it is due to the Japanese Yen (JPY) depreciating against the EUR and GBP. The JPY is a safe-haven currency, so when global equity markets rise, as they have been doing, the currency is relatively weak. If we see increased global equity market volatility, especially a market correction or bear market, the JPY will appreciate strongly against major currencies. So, while Japanese equities have produced relatively disappointing USD returns over the last three months, a significant allocation to the country is important in terms of maintaining a defensive portfolio.

Core Narrative

We remain constructive on risk assets, with modest overweight positions in each major equity asset class, as well as high-yield municipal bonds and commodities. Most recently, the Investment Committee added to international developed equities and cash in portfolios, funded from a reduction in investment-grade fixed income. We expect extremely robust U.S. economic growth this year, with the 10-year yield climbing toward 2% and the yield curve steepening, and we have repositioned portfolios with more exposure to value and cyclicals. Short-term risks remain, and volatility is possible, but we expect equities to outperform bonds over a one-year timeframe. We would encourage investors to ride through volatility and use any pullbacks to put excess cash to work.

Disclosures

Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corporation including, but not limited to, Manufacturers & Traders Trust Company (M&T Bank), Wilmington Trust Company (WTC) operating in Delaware only, Wilmington Trust, N.A. (WTNA), Wilmington Trust Investment Advisors, Inc. (WTIA), Wilmington Funds Management Corporation (WFMC), and Wilmington Trust Investment Management, LLC (WTIM). Such services include trustee, custodial, agency, investment management, and other services. International corporate and institutional services are offered through M&T Bank Corporation’s international subsidiaries. Loans, credit cards, retail and business deposits, and other business and personal banking services and products are offered by M&T Bank, member FDIC. 

Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of Wilmington Trust or M&T Bank who may provide or seek to provide financial services to entities referred to in this report. M&T Bank and Wilmington Trust have established information barriers between their various business groups. As a result, M&T Bank and Wilmington Trust do not disclose certain client relationships with, or compensation received from, such entities in their reports.

The information on Wilmington Wire has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. The opinions, estimates, and projections constitute the judgment of Wilmington Trust and are subject to change without notice. This commentary is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or a recommendation or determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the investor’s objectives, financial situation, and particular needs. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will succeed.

Past performance cannot guarantee future results. Investing involves risk and you may incur a profit or a loss.

Indexes are not available for direct investment.

Reference to the company names mentioned in this blog is merely for explaining the market view and should not be construed as investment advice or investment recommendations of those companies. Third party trademarks and brands are the property of their respective owners.

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Clement K. Miller, CFA

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