Macroeconomic concerns have remained top of mind among global investors, sending key stock market indices into a volatile trading pattern.
In Brandes’ view there are two core issues driving markets:
• the potential for a global economic recession, and • concerns regarding systemic instability in Europe
Our overall assessment is that there are significant risks to be accounted for and the path to worldwide economic recovery will not be swift or without hardship for many countries and companies — nevertheless, we believe the recent correction is overdone and that investors could potentially benefit from holding undervalued equities today. We provide some perspective on each of these topics below.
Global Economic Recession Risk
Our view has been, and continues to be, that large government fiscal deficits, relatively high debt-to-Gross Domestic Product (GDP) ratios, and protracted deleveraging of households, will likely inhibit growth for many developed nations in the decade ahead. We also incorporate a rising risk of a global recession, or at the very least low nominal growth, within the next two years. However, this scenario appears to be more than built into the price of many businesses today. In fact, we see established businesses that are priced as if they will have flat or negative growth for the foreseeable future when their operations and industry dynamics suggest otherwise. Put another way, we believe the intense focus on the question of whether we are about to slip into a recession has caused prices of many attractive businesses – including those that we believe are likely to maintain or grow profits even during a recession – to fall too far.
Overall, we are underweight cyclical businesses – specifically the materials and industrials sectors – out of concern that prices of many companies did not reflect the potential for a downshift in the business cycle. Now that expectations in the market appear to be adjusting, we may see more opportunities present themselves in these areas.
Systemic Instability in Europe
Market participants are becoming increasingly worried that European countries may not be able to achieve the right balance of fiscal austerity and economic growth to allow their debt-to-GDP levels to be lowered to more sustainable levels. Concerns that had previously been confined to economically smaller countries such as Portugal, Ireland, Greece, and Spain, have now spread to Italy and France. As a consequence, investors are requiring higher rates of interest for loans to these countries and are factoring in a greater potential for debt defaults, potential decomposition of the Euro, and a widespread loss of confidence in the banking system.
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