Synchronised Global Economic Growth & Stock Returns

There is a wide consensus that in 2017 we have witnessed a broad based global economic pick-up. This has been accompanied by all major equity market indices posting strong gains with many hitting new highs. Emerging markets, Europe, the US and Japan have led the way. However within markets there has been a wide dispersion of returns. Leading UK fund manager Neil Woodford recently highlighted that in the year to 31/8/17, eight stocks accounted for just over 50% of the gain of the FTSE All Share index returns with the remaining 650 stocks making up the rest. These eight stocks were Unilever, Diageo, Glencore, Vodafone, Prudential, British American Tobacco, Rio Tinto and HSBC. Woodford concludes the UK equity market has been narrowly led by stocks exposed to Chinese credit growth.

On a similar theme Bill MacQuaker from Fidelity noted that just four stocks accounted for the two-thirds of the move in the MSCI Asia Pacific (excluding Japan) Index over the last year and if you missed out on holding these companies your returns would appear pedestrian. MSCI have created a very wide range of global and regional stock indices which tracker funds invest in. The MSCI World Index is a market capitalisation weighted index of 1,652 global stocks from 23 developed markets. The index rose approximately 18% over the first 11 months of 2017, a decent return. Whilst I do not have full data I suspect much of this rise is due to strong gains from a few companies. For example Apple the largest constituent of the index at around 2.27% is up nearly 47.5% in 2017 whilst the next biggest stock, Microsoft at about 1.44% of the index is up around 34.6%.

So what do I conclude from these observations? First it is clear that the broad based global equity rally reflected by index returns masks a wide disparity of stock returns within each market. This challenges the view that equity markets are universally expensive across the board. Certain sectors and stocks clearly are but good stock-picking fund managers will find opportunities to invest at decent prices in strong undervalued companies with good earnings growth. At the same time savvy investors might avoid the current winners. For example Woodford observed that whilst the share prices of the super eight stocks (my phrase), have risen sharply, earnings forecasts have lagged. For example HSBC has rallied around 66% since the June 2016 lows even though the earnings forecast is up only 5% in the current year. Conversely Woodford highlighted other companies such as Lloyds Bank and the AA where earnings growth has been good but share prices have fallen, in the case of Lloyds since its May 2017 peak. Domestic UK stocks now trade at a rare discount to UK exporters and it is in these domestic sectors such as healthcare that Woodford is investing. Aside from the opportunity set here, sector and stock selection is also about mitigating risk. If the Chinese economy stalls and the burgeoning bad debt bites the biggest stock fallers in the UK may well be the super eight. The positive side here is that other parts of the market with less bloated valuations should offer defensive qualities.

As we approach the year end I am pleased to have been proved wrong that I called a stock market crash, which didn’t happen. I think with hindsight I misjudged the equity markets to be universally highly valued. Indices might have peaked in 2017 but most stocks seem not to have joined the party, enviously watching from the side lines as the likes of Apple and the super eight jived merrily on the dance floor. Looking forward into 2018 I see selective opportunities for these bridesmaid equities. The word selective is key here. Active fund management should be favoured over passive index tracking. At the same time the risk of a hangover for the dancers could lead to a market correction.

The content of this blog is my own understanding of the global economy and stock markets. My comments are intended as general commentary only. Nothing in this article should be construed as personal investment advice, including to buy shares such as Lloyds Bank. You should seek individual advice based on your own financial circumstances before making investment decisions.