Bank of America Merrill Lynch Global Research have published a report on Asia/EM Equities.
• Pause in China’s tightening, better global growth and lower for longer inflation – turning tactically bullish on Asia/EMs
• Oligopoly power has risen post-crisis in US/Europe, suppressing wage growth and inflation
• Post GFC, world increasingly artisanal/gig => less bargaining power => high economic insecurity/income vol & lower inflation
We have been structurally bullish for over a year
While we have been structurally bullish on Asia/emerging markets (EMs) since April-2016, we have been tactically neutral since late February. Instead of focusing on a big market call, we instead suggested selling energy and materials stocks, worried about an impending nominal growth slowdown in China. We were also worried about the elevated levels of Risk-Love (Equity sentiment) in the developed equity markets and a prematurely aggressive Fed. Instead we were overweight tech-heavy markets like China, Korea and Taiwan, and had a contrarian overweight in Turkey.
Back to tactically bullish. China stable. Global growth better, inflation lower.
New information is in, and we are reverting back to both tactically and structurally bullish on Asia and EMs. Three things have changed. 1) We think China’s monetary/credit cycle indicators are taking a pause from ongoing tightening. 2) Global growth and EPS estimates in both Asia and EMs continue to be more resilient, rising from 15.7% to 19.5% for Asia ex-Japan and from 17.9% to 20.4% for EMs in the past three months. Growth is more pervasive than expected, with 89% of global PMIs above 50, compared with 84% three months ago – any expected slowdown will come from this higher growth trajectory. 3) Most importantly, we share important new research that suggests inflation is withering on the vine, and unlikely to rise.
Strong global growth and low inflation equals a Goldilocks environment for equities. We agree with Global Strategist Michael Hartnett that the Icarus trade for risk assets has longer to run. We suggest investors buy Asia/EMs – specifically China, Korea, Taiwan, Turkey, and focus on technology and select interest rate sensitive sectors. We are closing out our underweight on energy and materials – it is yesterday’s story.
Low, and lower for longer inflation – new research on flat Phillips Curve.
Regular readers know that we think the world is old, indebted and unequal – this combination leads to lower nominal growth. Two new forces are at work, post-crisis:
Oligopoly power has risen post-crisis in the US and Europe. This suppresses wage growth. The percentage of industries where the top 3 firms have gained market share has increased from 42% during the period 2001-07 to 59% during 2007-16 in the US and from 39% to 69% in Europe. These big players can, and have suppressed wages as a fraction of their rising revenues. This keeps inflation lower. The profit share is up at these “superstar” firms, supporting equity valuations, and suppressing wage-driven inflation. Which also raises equity multiples. Alas, even the financial sector, long immune to this, has succumbed.
We are back to an increasingly artisanal, gig economy that preceded the industrial revolution. This has intensified post the Global Financial Crisis. Artisans and “gig-sters” have less power to demand higher wages. Economic insecurity and income volatility is high at both ends of the income spectrum – not a recipe for strong wage demand and inflation.
The Phillips curve has been flattened. At any unemployment level, wage growth/CPI are lower than they used to be.That is the central point.
We are not sure central bankers can target asset prices down and volatility up. The deflationary consequences would be severe. Buy some risk. Asia and emerging markets have reasonable valuations, fairly valued currencies, 20% EPS growth, prospective 6% free cash flow/sales in 2018, and the lowest financial vulnerability in two decades.