The year now drawing to a close has been a difficult one for investors in international (non-US) equity markets. A healthy advance until May was followed by a steep decline, bottoming in September with only a partial recovery in the final quarter. For the year-to-date (through December 22), our benchmark ETF for the international equity markets, iShares MSCI ACWI ex US Index Fund(O:ACWX), is down 5.24%. Global economic growth, likely to be about 3% for the year, has been disappointing in comparison to past recoveries, despite very accommodative monetary policies and easing fiscal restraint. A particularly weak third quarter and a small, 3% devaluation in China’s currency spooked equity markets, but these setbacks are proving to have been a mid-course correction, not the precursor of an end to the recovery. The advanced economies as a group registered relative stable growth at 2%, a slight acceleration from 2014’s 1.9% advance and also slightly above estimated trend. In contrast, the emerging markets continued to slow down from last year’s 4.9% pace to an estimated 4.1% rate for 2016, which marks the sixth consecutive year in which the growth rate for the group declined.
Moderation in China’s very strong growth from 7.3% last year to 6.8% this year, while certainly not a “hard landing,” has had a significant effect on both countries in the Asia region and on global export markets. The Chinese economy, now the globe’s second largest, is navigating a correction from a massive over-investment cycle and a transition away from manufacturing and heavy industry towards greater emphasis on domestic consumption, technology products, and services. This sea change is having ripple effects around the world. Along with this, other emerging-market economies are in the midst of a major deleveraging cycle. Excessive current account deficits have weighed on some countries, including Brazil, South Africa, and Columbia. Persistently low commodity prices are leading to cuts in investment in commodity sectors. For many emerging markets, including China, private sector debt is disturbingly high, making countries vulnerable to rising interest rates. External conditions are a headwind for most emerging markets, with capital inflows slowing and external financial conditions tightening.
Emerging Markets
Emerging equity markets reflected these headwinds. The iShares MSCI Emerging Markets ETF (N:EEM), is down 14.96% year-to-date. The weakening of emerging markets’ currencies versus the strengthening US dollar affected these US dollar returns. The Deutsche X-trackers MSCI Emerging Markets Hedged Equity ETF, (N:DBEM), which includes a hedge against this currency factor, is down 11.36% year-to-date. China’s equity markets, which boomed earlier in the year, also swooned, with the SPDR S&P China ETF (N:GXC), still down 4% year-to-date, despite a recovery in the final months of the year. The equity market of another emerging-market economy that registered a strong 7+% growth this year, India, also was caught in the downdraft, with the iShares MSCI India ETF (N:INDA) declining 7.96% year-to date. For the equity investor in emerging markets, there was no place to hide.
The advanced-economy equity markets have been the leaders in 2015 as their economic growth, while lackluster by historical standards, continued to accelerate. Outside the United States, both the Japan and the Eurozone markets outperformed. The iShares MSCI Japan ETF (N:EWJ) is up 9.34% year-to-date; and the iShares Currency Hedged MSCI Japan ETF (N:HEWJ) is up 9.63%, reflecting the stability of the yen/US dollar rate over the course of the year. The currency factor was important for the Eurozone, however. The iShares MSCI EMU (Eurozone) ETF (N:EZU) declined by 0.97% year-to-date, but the hedged iShares Currency Hedged MSCI EMU ETF (N:HEZU) advanced a healthy 7.59%.
Looking forward to 2016, we expect a further modest improvement in the global economic growth rate to 3.5%, with advanced economies continuing at slightly above-trend growth rates and emerging-market economies stabilizing and performing slightly better than in the current year. We do not expect a sharp reversal in emerging-market equities; but some individual markets with better growth prospects, economic reforms, and attractive valuations may provide opportunities for outperformance. In Asia, China, Taiwan, Korea, India, and the Philippines are all worth watching, as are Mexico in Latin America and Poland in developing Europe.
Among the advanced-economy equity markets, Japan continues to look attractive in 2016, with the Bank of Japan’s latest package of policy changes adding significant further easing that is bullish for Japan’s equities. Also in Asia, Hong Kong is looking more attractive after a difficult autumn. The Eurozone economies will continue to benefit in 2016 from the European Central Bank’s expansive monetary policies. National equity markets in the Eurozone are likely to continue to differ considerably in their performance. This past year, Ireland, Belgium, and Denmark were the strongest performers. Among other advanced economies, Canada and Australia have been suffering from the sustained weakness in the markets for their commodity exports, including oil. Should those markets finally stabilize in the coming year, which is not at all a sure thing, their equity markets, particularly that of Australia, could improve significantly. Overall, differentiation between national equity markets, both within the emerging-market area and within the advanced-economy area, will be essential.
Bill Witherell, Chief Global Economist.