DM Equity Allocation Model For Q1 2019

We are pleased to introduce our new Developed Markets (DM) Equity Allocation model. Building on the success of our EM model, this new framework extends our analysis to cover 24 DM equity markets. Our analysis is meant to assist global equity investors in assessing relative sovereign risk and optimal asset allocation across countries within the DM universe.

 KEY POINTS

  • Global equity markets have stabilized in the wake of the Fed’s about face this year
  • MSCI World is on track to test the December 3 high near 2073, which coincides with the 200-day moving average.
  • We believe it is very important for investors to continue focusing on country fundamentals
  • Our 1-rated grouping (outperformers) for Q1 2019 consists of Ireland, Singapore, Austria, Norway, and Sweden
  • Our 5-rated grouping (underperformers) for Q1 2019 consists of Germany, Greece, UK, Italy, and Portugal 

 

DM EQUITY OUTLOOK

Global equity markets have stabilized in the wake of the Fed’s about face this year. Indeed, the more dovish US interest rate outlook remains a major factor behind recent equity gains. We still think markets are underestimating the Fed’s intent to tighten in 2019. The implied yield for the January 2020 Fed Funds futures contract is currently trading at 2.39%, which implies very low odds of a rate cut this year.

MSCI World traded just below 1800 on December 26 at lows not seen since February 2017. Since then, MSCI World has rallied around 13%. It is on track to test the December 3 high near 2073, which coincides with the 200-day moving average. After that is the November 8 high near 2090. Beyond that, we hesitate to make any further calls. We remain very concerned about the global headwinds and do not believe that the liquidity story is enough to offset this.

MSCI World is up 9.1% YTD. This compares to 10% YTD for MSCI EM. It’s worth noting that the correlation between EM and DM stocks is currently 0.65. Whilst below the September peak near .80, it is above the low around 0.58 at the start of this year. Within DM, the best performers YTD have been Israel, Belgium and Austria, while the worst have been New Zealand, Australia, and Singapore.

We believe it is very important for investors to continue focusing on country fundamentals. Hedging out currency risk will become more important for US investors if the strong dollar trend resumes. Furthermore, we continue to look for potential divergences within DM. Regionally, Europe is the best equity performer so far in 2019 (9.5% YTD), followed by North America (9.5% YTD) and Pacific (6.7%).

Our 1-rated grouping (outperformers) for Q1 2019 consists of Ireland, Singapore, Austria, Norway, and Sweden. We note that of the top 10 countries, 5 are in Europe, 4 are in Asia, and 1 is in North America.

Our 5-rated grouping (underperformers) for Q1 2019 consists of Germany, Greece, UK, Italy, and Portugal. We note that of the bottom 10 countries, 9 are in Europe and 1 is in Asia.

 

MODEL PERFORMANCE

Our proprietary DM equity portfolio has risen 8.7% YTD, slightly underperforming MSCI World (9.1% YTD). We will update our model performance regularly in Q1 2019. Our first quarterly update for Q2 2019 will come out in April.

 

 

MODEL DESCRIPTION

Our equity allocation model is meant to assist global equity investors in assessing relative sovereign risk and optimal asset allocation across countries in the DM universe. The countries covered include all 23 of the countries in the MSCI World Index. We have also included Greece in this model. Even though MSCI puts the nation in MSCI EM, we continue to view it as DM.

A country’s score reflects its relative attractiveness for equity investors – the likelihood that its equity market will outperform the rest of our DM universe over the next three months. A country’s score is determined as a weighted composite of 15 economic and political indicators that are each ranked against the other 23 countries in our model DM universe. Categories are industrial production growth, real interest rates, export growth, expected P/E ratio, real bank lending, yield curve steepness, real money growth, GDP growth, investment/GDP, per capita GDP, inflation, retail sales, political risk (EIU), leading indicators, and ease of doing business (World Bank). A country that is typically ranked first in many of the categories will end up with a low composite score (the lower the better).

From a portfolio construction standpoint, we are benchmarking to MSCI World. As a result, our BBH model portfolio weights will be Underweight/Overweight compared to the MSCI weights.

  • Countries that are rated 1 will have a BBH weight that is 2.0 X MSCI World weight.
  • Countries that are rated 2 will have a BBH weight that is 1.5 X MSCI World weight.
  • Countries that are rated 3 will have a BBH weight that is equal to MSCI World weight.
  • Countries that are rated 4 will have a BBH weight that is 0.8 X MSCI World weight.
  • Countries that are rated 5 will have a BBH weight that is 0.6 X MSCI World weight.

 

To have the BBH model portfolio weights add up to 100%, there may be some exceptions to the rules outlined above. However, we will always try to keep to these parameters as closely as possible.

 

CHANGE IN METHODOLOGY AND COVERAGE

In the past, we have taken a simple average of each grouping (1 through 5) to determine model performance. That allowed small markets to skew the results. We are now taking a weighted approach, with country returns weighted by the BBH model weightings. Then, we compare our model performance against the benchmark MSCI World.