Will the Fed’s Moves Reshape the Global Investment Landscape?

Join Interactive Brokers’ Andrew Wilkinson and WisdomTree’s Director of Macroeconomic Research, Aneeka Gupta, as they dive into the latest trends shaping global markets. From the Fed’s recent rate cuts to emerging opportunities in Japan and China, Aneeka breaks down the insights investors need to know heading into the fourth quarter.

Summary – IBKR Podcasts Ep. 203

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome everybody to today’s podcast with me, Andrew Wilkinson, at Interactive Brokers. And a bigger welcome to Aneeka Gupta, who is the Director of Macroeconomic Research over at WisdomTree in London. How are you, Aneeka? 

Aneeka Gupta 

I’m doing great, Andrew. Apart from the wet, cold weather outside, I’m doing very well. Thank you. 

Andrew Wilkinson 

The autumn has begun, hasn’t it, in earnest? So today we’re going to discuss global markets. We’re going to do a bit of tour de force with Aneeka and then at the very end I’m going to ask her to pick one of the markets that she likes the look of.  

So Aneeka, heading into the fourth quarter of the year the Federal Reserve set off on an easing path with its monetary policy, cutting rates recently by a 0.5% more than the market expected. Can you please describe to the audience how you see the U.S. equity market poised valuation wise as we head into the fourth quarter? 

Aneeka Gupta 

Andrew, I think before just moving into valuations, I just wanted to clarify that there have been a lot of different views on the FOMC. And clearly Powell did exactly as he said at the Jackson Hole conference, where he switched the focus from the labor markets and responded aggressively towards the labor market weakening, which we essentially saw back in August. And he rightly did so and went ahead with a much more aggressive pace of tightening, starting the easing cycle with a 50-basis point rate cut. 

So that has pretty important implications because the trajectory ahead, we again have a bit of a push and pull where the market is fighting the Fed. The market is expecting nearly 75 basis points of interest rate cuts. 

Whereas if you look at the Fed’s own projections, the Fed is expecting 50 basis points worth of interest rate cuts. So that in itself has very important implications because we were writing our outlooks, our view is that what the equity market really is suffering from right now is extreme concentration, not just from a geographic perspective, because it’s dominated by the U.S., but also from a sector perspective, dominated by longer duration growth, tech-oriented stocks. 

But at the same time, that high concentration from a geographic regional perspective, as well as sector perspective, is ripe for change and the culmination of the monetary easing cycle that has kicked off at such an aggressive pace clearly lends into that narrative very well. 

So our view is that concentration opens up room for plenty of opportunity in the market. If you look at valuations of the Magnificent Seven, it’s nearly 1.7x from a price to earnings perspective that of the S&P 500. So if you look at the S& P 500 including the Magnificent Seven, you’re looking at very high valuations north of 25x price-to-earnings ratio. 

If you compare that to MSCI World, you’re looking at somewhere around the 20x price-to-earnings ratio mark. So it is quite elevated and this is where introducing that barbell approach becomes very important so that investors that have exposure to the U.S. broaden it out, diversify that exposure and adopt a barbell approach, whereby they keep hold of that existing exposure to the Magnificent Seven, given that higher earnings growth projection. 

At the same time, start to introduce more value-oriented small cap segments of the market that are likely to benefit from this easing a monetary cycle that is likely to give way. 

Andrew Wilkinson 

Aneeka, let’s turn to China, where the People’s Bank of China very recently announced a series of measures aimed at not only supporting the economy, but also the equity market. What do you make of those measures, and are they enough to support a fourth quarter rally for Chinese equity prices? 

Aneeka Gupta 

Yeah it’s been quite interesting. This morning itself, we’ve had Beijing hold a surprise Politburo meeting. And it’s one of the first times they’ve actually held it in September. And clearly that is providing a message of a sense of urgency. Clearly, Chinese leaders have vowed to intensify fiscal support for their economy. 

And it’s important to keep in mind that the Politburo statement is following measures this week from the central bank. And financial regulators that we received from the start of this week alone primarily aimed at supporting the economy.  

Now, if we look at the individual measures that have been announced since the start of the week the policy package really is one of the broadest in quite a while, and it’s spanning across interest rate cuts to support the property sector alongside the stock market. 

On the counter cyclical measures, we’ve seen a 20 bps rate cut on the 7-day reverse repo rate. Clearly, that’s a much bigger step compared to the usual, given that the prior cuts were primarily in the 10-basis point range. In addition, we’ve seen a 50-basis point cut in the reserve requirement ratio, and that is quite consistent with prior moves. 

But for me, what was most interesting was the forward guidance, which was for another 25 to 50 basis points cut by the end of year. And that is quite rare. We typically do not receive that.  

Now, this clearly suggests that policymakers they’re trying to improve their communication with the rest of the world and bringing forward that effective policy implementation. 

Now, the property measures that were announced, I would say, the lowering of the rates on outstanding mortgages does help to ease household mortgage burdens. They should also help stimulate consumption. However, the improvement that we saw in the relending facility for SOE, state owned enterprises, to buy housing inventories might not be as beneficial.  

Because if we reflect back on the program that was introduced in May, that provided loans by the PBOC at a preferential rate of 175, 1.75% to the banks that lend to state owned enterprises backed by local governments. Yet, if we look at the progress of that, among the 200 cities that it was announced to, only 29 cities actually announced plans to actually participate in the program. 

So, it hasn’t been as successful. And so, this particular measure is unlikely to see a lot more progress if the prior measure, which was announced on a similar scale, has yet to see a big pickup. 

In addition, I would point out that the rental yield on public housing is low. It’s around 1.5% compared to the current funding cost at around 2% for local government bonds and 1.75% for the PBOC Lending Program. So that implies that state owned enterprises would actually need to rely on potential capital gains from houses in order to achieve those positive returns ahead. 

So I think these two factors tell us that on the property side, the measures were somewhat lacking in momentum. However, on the counter cyclical measures, I think the measures were quite strong. And now if we look at the stock stabilization fund, I would say that could help prop up sentiment in equity markets over the short term. 

Clearly the PBOC is trying to support the stock market to help drive that confidence, support household wealth that is actually tied to the equity market, yet in itself, it’s unlikely to solve the long-term structural problems in the economy, which have really been the cause of the decline in Chinese equity markets. 

So, I would also point out that this morning’s announcement while there were no specifics that were offered by the Politburo on fiscal spending, the Ministry of Finance is planning to issue ¥2 trillion Yuan of special sovereign bonds this year. So should we see these measures that we received over the course of this week also being accompanied by fiscal stimulus, I believe it’s likely to have a more lasting impact on the recovery in Chinese equity markets over the course of time. 

Andrew Wilkinson 

Let’s turn our attention to Japan, where the stock market this year has been on fire, continuing a multi-year rally, and I think we’ve seen it at the highest level, all-time highs, and the highest since, I think, 1989.  

Have investors missed the boat, or do you have greater confidence now in the Japanese economy, Aneeka? 

Aneeka Gupta 

Yeah. So it’s been quite interesting, Andrew, as you mentioned, we did see Japanese equity markets hit a 45 year high, but then they also had to face the wrath of the August selloff, where in a single day we had nearly 22 percent wiped out from the Nikkei (Nikkei 225) stock market.  

And, that clearly gives usand gives investors a warning sign of the impact of the Yen, and especially the impact of the Yen on export-oriented stocks. Now, there’s no denying that Japan is emerging from a deflationary spiral, and the Japanese equity market is now seeing some stability coming back into the market. 

The Yen has appreciated, but is now stabilizing around the $1.44 per Yen mark. And I think it’s important to see that recovery that we saw over the first half of 2024 has not been even because we’ve essentially seen large cap, value-oriented stocks outperformed the smaller caps in 2024, and that’s primarily because the Japanese exporters have delivered some very strong earnings results, aided by that weakness of the Yen. 

Clearly, for us, the long-standing theme in Japan continues to be the recovery in CapEx. And that will be the theme that will support Japanese equities over the long run. In addition, the wave of corporate governance reforms continue to support Japanese equities and also tend to attract foreign investors back into Japan. 

We’ve seen since the announcement of the Tokyo Stock Exchange’s corporate governance reform on price to book ratios, the ratio of companies that have actually increased their dividends in the last fiscal year reached the second highest level since 1985. We’ve seen share buybacks that have been announced, along with the fiscal year results, also reach their highest levels in terms of both number and value since the financial year 2009. 

So there’s no denying that these reforms are going to result in Japanese corporates that are cash rich into utilizing that excess cash a lot more effectively, improving companies’ earnings and their shareholder distribution. And that is what is attracting the international community.  

And we’ve seen it also being followed by a slew of investments by foreign funds in Japanese equities, be it Bain Capital investing 5 trillion in Japan for the next five years, Blackstone coming in with 1.5 trillion Yen over the next three years, KKR over the next ten years, CVC and Carlyle. So, we’re looking at some of the biggest names in private equity coming into these Japanese equity markets for a longer-term investment proposal. 

Now clearly the trajectory of the Bank of Japan is going to be quite important because most of a very large percentage of Japanese revenue, we’re talking about north of 50%, relies on exports from the rest of the world. And hence, the trajectory of the Yen is extremely important on how competitive Japan can be in terms of their exports to the rest of the world. 

Now there’s been a lot of human cry over the Yen strengthening, and I would just say that the Yen, a weaker Yen is actually bad for consumer spending, and we saw that in the GDP numbers. So while wages have been growing in earnest. In fact, if you look at it, wage increases reached their highest level since 1993. 

Real incomes, they still haven’t risen. And that’s because that transmission is not really taking place. So a big factor resulting in the government’s growth downgrade was actually attributed to sluggish domestic consumption. Now as we’ve seen a gradual Yen appreciation, that should support that recovery in real wages and bring back that revival of household purchasing power. 

But the key question is up to what level does it balance out the benefit to the Japanese consumer alongside the benefit to the Japanese exporter? And for us, that really comes out in the value that most Japanese export companies put forward in the most recent Tanken report for July where they provided a Forex assumption of 144 Yen per dollar. 

And hence, if we take into consideration the movements of the Yen over the prior year, we’ve seen the Yen fall to 156 Yen per dollar over the course of April to June. That served as quite an important reserve. We would now need to see the Yen average 140 Yen per dollar for the next three quarters of the fiscal year to align with that corporate assumption for financial year 2024. 

So given the current level of the Yen, we don’t expect or see the need for companies to have to lower their guidance. They can still stick to the guidance that they have provided for the quarter ahead. And hence we do see Japanese equity exporters still remaining in poor position for investors wanting to get that access to and high-quality companies. 

Andrew Wilkinson 

So, Aneeka, let’s turn to emerging markets, particularly in light of declining global interest rates. What are your most and least favorite emerging market economies at this point? 

Aneeka Gupta 

Yeah, I would definitely say that now that we’ve got the Fed embarking on the easing of monetary policy, that divergence in earnings growth expectations between developed markets and emerging markets, it’s yet to be reflected in valuations. In fact, I would say that the last time we saw a similar gap in valuations in the month when The Fed first cut rates was back in 1998, and subsequent to that, we had the MSCI Emerging Markets actually outperformed the S&P 500 by 20% over the course of the next 12 months. 

And so I would say that with fundamentals improving in most emerging market countries, it is notable that index valuations today are much lower than they were back then, even on an ex-China basis. We’re looking at a price-to-earnings ratio of about 14.5x, which is well discounted if you compare it to the S&P 500 or even the MSCI World. 

And the second key point is as the Fed cuts its policy rate, emerging market central banks across the world will also have room to cut rates in tandem. That’ll help lower their funding costs, it’ll also boost their liquidity, and it’ll also support stock market performance.  

We’ve put down a list of countries that do have room to cut. Amongst that list, eighteen of them are from emerging markets, and that includes economies with pretty strong weights in the MSCI Emerging Market Index, such as Mexico, Brazil, Indonesia, as well as India. So I would say that these factors will definitely serve as an important catalyst for emerging markets. 

And in addition, according to the IMF, we’ve seen developed-market GDP actually begin to contract if you compare it to emerging market GDP. And the resilience that we’ve seen in emerging market GDP over the course of the Covid pandemic, over the last two years has really reestablished a good healthy growth differential and according to the IMF’s latest working paper, they do expect that to remain in place. 

So that’s another factor that we believe is likely to support EM equity recovery. Based on that growth differential, support evaluations. We’ve also now seeing a raft of measures being introduced by China to restore that confidence in its ailing property sector. And I think those factors do move in to help aid emerging market equities as a whole. 

But clearly, I would highlight that within emerging markets there have been quite a few bright stars. Taiwan definitely stands out. We’ve seen the AI boom continue to be that key driver for growth in Taiwan. Just AI related demand alone has contributed to exports and gross capital formation in the first half of 2022, and it’s really helped drive that growth. 

We’ve also seen some strong wealth effect by higher property prices and equity markets really support that consumption locally in the Taiwanese market. Now next favorite that comes to mind is India. Again, it emerges as a very new source of global growth. India, fortunately, unlike many countries and many leading economies in the rest of the world, has amongst the youngest most favorable demographics, and that stands to benefit its economy. 

We’ve also seen the Indian Prime Minister, Narendra Modi, win a third consecutive term. It was a much tighter general election than anticipated in June. However, it does lend to political continuity post the elections and provide business friendly policies going forward. So I would say that growth does remain on a firm footing and it allows India to aim for becoming the world’s third largest economy by 2027. 

A third emerging market economy that we are seeing a feature very similar to Japan in is the government’s corporate value up program. And that really aims to emulate Japan’s success at improving capital management by listed companies. So we’re seeing a lot of South Korean companies traded valuations, which are, I would say, on average, the lowest among emerging market peers. 

And despite them being home to the most globally dynamic and innovative companies within the semiconductor and materials sector, so there’s definitely a valuation gap at play there. which investors can exploit and take advantage of.  

Another geographic area, I would say Latin America has really provided some very strong opportunities this year. 

They continue to offer high nominal as well as real yields. We’ve seen Latin American equities actually post a stronger performance in the first half of 2024. In Mexico we’ve seen the new president elect, Claudia Sheinbaum, show a very strong margin of victory in the June election. 

And that did raise some concerns amongst investors that could push through constitutional reforms and impact Mexico’s business environment. Yet Mexico has really benefited from the nearshoring effort alongside very high consumer confidence. Chile has been another one benefiting from the export of key commodities such as copper that really remain crucial to the energy transition. 

Finally, it would be very hard for me to avoid Turkey. We’ve seen a very strong rebound in its economy. It’s clearly benefiting from the efforts by European countries to nearshore their production, and that’s boosting manufacturing hubs in Turkey. We’ve also seen a sharp turnaround in monetary policy, series of interest rate rises initiated in June of last year, and that’s really brought the main interest rates from 8.5% all the way up to 50%. Lifting the rates for domestic savings in the Lira. So I think these are some very interesting economies within the emerging markets that we still see opportunity in. 

Andrew Wilkinson 

Well, finally, Aneeka, if you had to pick one of the above, U.S., China, Japan, or a single emerging market for the rest of the year, which one would you pick? 

Aneeka Gupta 

Well, Andrew, I would definitely say emerging markets. So if investors are, putting together a long-term view, they want to allocate into equities over the long term, the first thing they would want to do is allocate to an asset that is trading at a valuation discount. That, in order of selection, just points you in the direction of emerging markets. 

We are seeing a lot of catalysts move in favor of emerging markets starting from the easing cycle, which gives emerging markets in itself a lot of room to ease further. They’ve also been quite prudent during the COVID pandemic in actually reducing rates, being ahead of the curve. 

And then subsequently when they saw inflation coming down gradually, they’ve also been quite prudent in raising those rates. So I would say they’ve managed the situation much better than developed markets, central banks that have been late quite behind the curve, I would say. 

And in addition, we’ve seen a number of upgrades. So the number of upgrades for emerging markets have surpassed the downgrades, which again lend to that theme of improving macroeconomics, improving momentum taking place within the emerging market landscape, and those better upgrades that are taking place will essentially give them more favorable facilities for borrowing at much better interest rates. 

So it really does work in their favor. And I would say even if you look at the earning cycle, we’re seeing a lot of change. 

From 2000 all the way to 2011, we saw emerging market earnings per share actually rise in a very strong way by 17.2% per annum. 

And so in lockstep, we did see that decade show some very strong performance by emerging market equities. If you compare that to developed markets, ex. US, they increased just by 5.9% per annum. And today what we’re seeing is a resumption of that activity. The U.S. is now the center of overexuberance, macroeconomic imbalances, which are probably due for a correction. But if you look at EM external and fiscal balances, they’re largely quite healthy. It’s setting a good foundation for strong earnings growth. And after we’ve seen that two-year decline, the twelve-month earnings-per-share emerging market growth forecasts have actually been rising since October of 2023 and they’re up about 9% moving all the way up to close to 15% as of the end of August. 

Even from an earnings perspective it is showing a tremendous opportunity for emerging markets over the longer time frame. 

Andrew Wilkinson 

Aneeka Gupta, Director of Macroeconomic Research at Wisdom Tree Europe in London. Thank you very much for being my guest today. 

Aneeka Gupta 

It’s my pleasure, Andrew. Thank you so much. 

Andrew Wilkinson 

Thank you, Aneeka. Hopefully we’ll see you again shortly, and to the audience, please remember to rate our recent episodes wherever you download your podcasts from.