There is still upside potential for domestically-oriented equities relative to those that are globally-geared in the near term.
S o far, the Fed has been the most proactive central bank in terms of promoting economic growth. Conversely, the slow moving ECB has contributed to regional economic weakness, both in Europe and in developing countries, particularly via more restrictive financing conditions including trade credit. China has also been slow to step on the accelerator, reflecting lingering inflation fears and a reluctance to make any major decisions ahead of the leadership handover.
All of this is helping drive up the U.S. leading economic indicator relative to the rest of the developed world, heralding further equity outperformance of domestically oriented industries versus globally focused ones. The same is true of relative purchasing managers surveys, which are moving in favor of the U.S. Relative economic strength is also reflected in pricing power trends. Domestic industries are enjoying a distinct advantage in terms of selling price momentum.
The message is that domestic-sourced profits are still poised to outperform, regardless of the recent slippage in relative earnings revisions.
What could change the balance of power?
C urrency competition helps transmit developed-country easy money policies to the developing world. Specifically, the recent appreciation in many EM currencies is already causing a verbal backlash. The latter is likely to morph into intervention in order to maintain competitiveness, which would provide a source of stimulus as foreign exchange reserves are created. Indeed, Asian currency swings consistently lead the trend in world export growth.
In addition, the decline in the U.S. dollar in general is a potential signal that domestic vs. global earnings leadership may be nearing a turning point. There are no signs of an inflection point in European growth, but sentiment toward Chinese economic prospects has improved and would be further supported if a concerted central government stimulus package is announced alongside additional monetary easing.
The recent GDP report and the firming in money and credit growth argue that a turning point in China may be looming. The objective message from our indicators is that the domestic vs. global theme is still intact, but has reached an advanced stage.
Bottom line?
If policy outside the U.S. begins to play catch-up and monetary conditions ease at a faster pace, investors should be preparing for some volatility in the coming months – which could mark at least an interim peak in this theme.
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