The rebound narrative is strengthening every week now and the JPM Global Manufacturing Index printed its third straight gain in October supporting the view that global manufacturing sector is on its way out its recession. But more importantly the slowdown in the manufacturing sector never created large spill over effects into the services sector so it might be that the global economy is turning back to trend growth. While the probability for this scenario is rising it’s still not a clear path and things could still reverse quickly with the supposedly US-China “phase one” trade deal as the biggest tail-risk to investors in the event the trade deal is not done.
Adding to
the positive change in global manufacturing PMI figures South Korea reported
overnight a strong gain in its current account balance to $7.5bn in September
suggesting economic activity is again picking
up in South Korea. As one the most sensitive economies to growth in Asia and
economic statistics that investors can believe it’s an important signal to the
market that the bleeding might have stopped for now. South Korean financial
assets have recently performed well in tandem with the rest of the emerging
markets and the stronger Chinese Yuan has supported the momentum in emerging
market equities. If OECD’s global leading indicators (CLI) this month confirm a
turning point in September or at least that it’s imminent, so maybe in October,
then the global economy is shifting from contraction to the recovery phase and
in this phase emerging market equities have historically been the best
performing asset class.
European
leaders have pointed fingers at Italy for their intention to increase the fiscal
deficit, but the facts are that Italy’s fiscal deficit as a percentage of GDP
is expected to be -2.3% in 2019 which is well within the -3% threshold agreed
to in the EU’s Growth and Stability Pact. At the same time France, which is currently
the growth engine in Europe, is expected to have a deficit of -3.2% of GDP in
2019 as the French government has increased spending to support growth. Our
view is that Italy will be allowed to increase the deficit and there is room
with the primary surplus (government revenues -minus expenditures excluding
interest payments) of around 3.2%. This will create growth tailwind for Italy
and if growth globally rebounds Europe will benefit as well with Italian
equities potentially as the big winner.
Italian equities are valued at a 35% discount to global equities and have an
attractive 4% dividend yield on top of positive earnings expectations and the
potential for valuation expansion. Italian equities could be the contrarian bet
in 2020.
The biggest
decliner in the STOXX 600 Index today is the Danish facility service company
ISS down 17% as the company is lowering its outlook and longer-term guidance
for growth and operating margins. However,
the business is generating a stable free cash flow of DKK 2.6bn on an annualized
basis which given the current enterprise value of DKK 46bn translate into an
attractive free cash flow yield of 5.6%. Given the yield hunting investors this
stable business should be able to attract marginal buyers with this free cash
flow yield. The biggest risk for ISS is if there is a sustained slowdown in
the economy as increased bankruptcies will impact top line growth significantly.
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