International Equities at Year-End

Received from my friend David Kotok.

International Equities at Year-End: The Advanced Markets
December 19, 2013

This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at the OECD in Paris. His bio is found on Cumberland’s home page, He can be reached at

As the end of 2013 approaches, the global economy is still suffering from the financial crisis of 2008 and subsequent deep recession. Global economic growth slowed from 3.2% last year to an estimated 2.9% for 2013. Growth of the advanced economies is estimated to have been only 1.2%. Recovery in the US economy is broadening and gathering momentum but remains below the path of most past recoveries. The United Kingdom’s economy has also moved onto a solid recovery path, yet it still has a great way to go to make up for the ground that was lost. In contrast, the recovery in continental Europe is still very tentative in a number of economies, aside from Germany and several of its northern neighbors. In Japan, an unprecedented change in economic and financial policies, “Abenomics,” has aroused the world’s third largest economy from over two decades of stagnation and deflation, helped by a 16% depreciation of the currency.

Global equity markets registered much stronger returns than the above-noted modest economic performance might suggest. The MSCI World Index, in US dollars, is up 19% for the year to date (through December 17). Led by Japan (MSCI Japan up 20.8 %), the MSCI EAFE Index for advanced markets outside of North America advanced 13.7%. The MSCI US Total Market Index topped most markets with a 25.14 % advance, while Canada underperformed, with the MSCI Index for Canada essentially unchanged for the year to date (-0.05%). Also noteworthy has been the outperformance of small-cap stocks in the advanced markets. For example, the iShares MSCI EAFE Small Cap Index ETF, SCZ, is up by 20.8 %, while the iShares MSCI EFA Index ETF (large-cap) is up 13%.

The strong performance of the advanced equity markets in the face of weak macroeconomic fundamentals is likely due to several factors. Investors’ concerns about a number of risks that had been depressing markets have eased. The Eurozone appears to be addressing its problems and looks far less likely to break up; the Chinese economy seems to have avoided a sharp slowdown and to be gaining momentum; and the fiscal standoff in Washington has ended – for now. Another important factor is the stimulative monetary policies being pursued by the major central banks, with the prospect of very low interest rates continuing for an extended period. Corporate profits generally have been quite strong despite the modest economic growth. And equity markets typically look forward: investors foresee the global recovery gaining momentum in the coming year.

We, too, are generally optimistic about the advanced equity markets in 2014, although another 20+% gain seems unlikely. Two countries, Japan and the United Kingdom, and a region, Northern Europe, have the most promising prospects. In Japan the Abe government and the Bank of Japan are strongly committed to following through with their efforts to sustain the economic recovery and break deflation definitively by combining very aggressive monetary easing with a balancing act of debt consolidation and fiscal encouragement of the economy, along with far-reaching economic reforms. A test will come in the spring when the consumption tax is to increase. We expect the government to seek to partially offset the effects of this tax with a reduction in the corporate business tax and with new spending. The Bank of Japan will likely step up its monetary stimulus if that appears necessary. We expect further depreciation of the Japanese yen in 2014 and for that reason will continue to favor a Japan ETF that is hedged for changes in the yen/US dollar exchange rate: the WisdomTree Japan Hedged Equity Fund, DXJ. That ETF is up 32.3% year to date, while the unhedged iShares Japan ETF, EWJ, is up 20.31%. The longer-run performance of the Japanese economy will depend on economic reforms promised but still not clearly defined. The ultimate success or failure of “Abenomics” will likely hinge on the extent to which needed structural reforms are initiated and implemented. The jury is still out on that.

In Europe the United Kingdom economy looks now to be on firm footing and should advance at almost three times the 1% average expected for the Eurozone. The negative effects of the financial crisis and a housing overhang are declining; the government has eased off its somewhat overzealous fiscal austerity program; and the Bank of England is maintaining an accommodative policy stance. The MSCI UK Index is up 9.5% this year.

In continental Europe, Germany was one of the very few Eurozone economies to eke out positive GDP growth for the year, estimated at 0.5%. It is both the largest economy in the Eurozone and has the best macroeconomic prospects for the coming year. Positive investor expectations for the German economy and equity market lifted the MSCI Germany Index by 21.7%, considerably bettering the 16.6% advance for the French market, which has recently been losing ground to the German market.

The Eurozone continues to face substantial challenges, including further deleveraging and generally tight credit conditions as banks seek to strengthen their capital positions. Eurozone banks will face stringent stress tests in the coming months. The ECB may be faced with the threat of deflation and, if so, would likely respond with further easing. While there have been some important advances, establishment of a sustainable monetary union is still incomplete. Eurozone equity market performance in the coming year looks unlikely to match that of 2013, which was 18.9% to date for the region.

Outside the Eurozone, Sweden and Switzerland have strong, well-run economies that have been held back by the weakness of demand in their all-important European markets, as well as by their own strong currencies. The Swedish market, as measured by the MSCI Sweden Index, has gained 12.4% year to date, and the MSCI Switzerland Index is up 18.3%. These economies and markets should do well as Europe slowly recovers.

In the Asia-Pacific advanced markets, Australia, New Zealand, Singapore, and Hong Kong have all underperformed this past year. A continuation of the recent strengthening trend in China should help these markets in 2014, particularly that of Hong Kong.

Bill Witherell, Chief Global Economist

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