In the April edition of The Cornerstone Journal of Sustainable Finance & Banking we introduced the Cornerstone Capital Regional Strategy Model. Table 1 illustrates that, after updating the inputs, there is no change in our regional over- and under-weights.
Table 1: Cornerstone Capital Global Markets Equity Strategy Model
In terms of performance, Latin America, which is ranked underweight, has been relatively strong, gaining about 2% in the past month, at the same time the MSCI All Country World Index was up around 1%. There has been no change in the fundamental outlook – Latin America still ranks unfavorably both in terms of earnings and valuation.
Brazil is by far the most important country in the region, accounting for 58% of the MSCI Emerging Markets Latin America Index. The MSCI Brazil Index is up about 2% in the past month. It would seem that the rally has been driven by some investors betting on the failure of President Dilma Rousseff’s re-election bid. The hope is that, after the October election, a new administration will usher in new policies – since President Rousseff took office in 2011, the pace of Brazil’s economic growth has been only 2% annually on average. Meanwhile, economists expect Brazil’s inflation to reach 6.5% in 2014, which corresponds to the upper level of the official range set by the government.
Uncertainty about the election aside, the fundamental outlook for a weak economy and a likely inflation-driven interest rate hike suggests that the risk-reward scenario in Brazilian equities remains unfavorable.
Our other underweight, Europe excluding the U.K., was a relatively poor performer, remaining virtually unchanged during the month.
In terms of overweight regions, Japanese equities were roughly flat in the past month. Weighing on stock prices was a strong yen driven, in part, by geopolitical tension centered on the Ukraine, which prompted Japanese investors to sell large amounts of euro-denominated bonds. Strength in the yen has pressured Japanese exports. However, many economists expect that the Bank of Japan will engage in additional monetary easing policies later this year, which should support equities as a lower yen benefits corporate profits.
Our other overweight region, Emerging Asia rose about 2% last month, less than the roughly 6% gain in the CEEMEA region. The bearish consensus in emerging markets has reversed in recent weeks, with some of the more troubled markets (most notably Russia) outperforming those with stronger fundamentals. A number of factors are likely behind this shift in sentiment on emerging markets, including reduced geopolitical tension over Ukraine. In addition, market observers have also pointed to: (i) lower U.S. bond yields; (ii) prospective monetary easing by the European Central Bank; (iii) growing expectations of stimulus from the Chinese authorities.
Reflecting attractive valuations in Emerging Asia and the potential for stimulus measures in China, we remain overweight the Emerging Asia region, while staying neutral on CEEMEA given a weak fundamental outlook.