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The search for growth: Who is leading the charge?

19 June 2024

William Blair expects sector outperformance to become more widespread in the US, while Japan stands out as a market poised for growth and strong returns, as corporate governance reforms take root.

By Ken McAtamney,

William Blair Investment Management

While the European Central Bank was the first to cut rates this month, investors continue to play the waiting game for the rest of the major central banks to cut rates this year. In the background, global equities have been performing well – with healthy levels of economic growth and inflation.

We believe that the normalization of the post-pandemic global economy will result in both a broader distribution of growth and a shift of leadership from some of the recent mega-cap winners. This trend has become particularly prominent due to investors' flight to safety, as it has given way to the search for growth.

In the months ahead we foresee continued broad growth, particularly from the US, slightly less in Europe, and the potential for accelerated strength in Japan. All in, we believe developed markets will continue to grow by 2%-plus on a sustainable basis, with some countries clearly dominating the charge.


The US: Widespread sector outperformance expected

The US seems to have achieved a soft landing, with corporate earnings having turned out better than anticipated in the first quarter.

The S&P 500 index saw record highs in February of this year, rising above 5,000. Not surprisingly, the “Magnificent 7” stocks (otherwise known as Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms, and Tesla) continued showing off as top performers in the index, but tech was not the only sector to outperform. In fact, nearly three quarters of companies making up the S&P 500 managed to report earnings above expectations.

So, what does this mean in terms of U.S. market strength in the coming quarters? As impressive as it is to see certain tech companies dominate the index, we expect this will moderate. We anticipate sector outperformance will become more widespread, as the growth gap between the Magnificent 7 and the rest of the S&P 500 ultimately narrows.


Europe: Resilience shines through

Europe has demonstrated economic resilience over the past quarter, partly due to easing inflationary pressures and economic indicators show it is not the end of Europe's growth story.

While growth in the region appeared to have bottomed at the end of last year, we expect improvement in the coming quarters. Further bright spots in Europe have been indicated by the outpacing of corporate earnings, as well as the upward trend of manufacturing purchasing managers indices. These components characterise a market that has shown resilience, and one that we believe will continue to do so.


China: Promise amid challenges

Despite recent efforts to stimulate the Chinese economy, it still faces challenges in the near term. We expect this year's market performance to largely hinge on the economy's ability to recover whilst simultaneously increasing consumer confidence, stabilising the property market and improving youth unemployment numbers.

Ongoing geopolitical risks, however, are likely to affect stock prices. And while geopolitical tensions have somewhat eased in recent months, we anticipate chatter around policy to increase as the US election approaches, thereby potentially impacting the market.

Against this backdrop, we find Chinese equities are attractively valued compared to their own long-term averages and emerging market valuations more broadly. While China has historically traded at about a 4.5% discount compared to emerging markets, it is currently trading at about a 20% discount.

We believe now more than ever, it is crucial to consider the importance of active management within Chinese equities to benefit from the country's growth trajectory.


Japan: Among the strongest markets

Investors were fully optimistic about Japan's macroeconomic outlook and structural tailwinds earlier this year, as it proved to be one of the stronger markets in the first quarter.

From a macroeconomic perspective, Japan is now experiencing positive inflation at a sustainable level, marking a significant shift in the country's economy. The outcome of the ‘shunto’ wage negotiations in recent weeks resulted in Japan's largest wage increase since 1991, at approximately 5.3%. This surge in real wages is expected to fuel consumption growth, mirroring trends observed in the US and Europe.

Further painting the picture of continued strength in Japan is a revision to the country's corporate governance code. While the country has traditionally lagged in corporate governance metrics, a change to the corporate governance code is expected to address issues such as board independence and board diversity. The revision, which is currently underway, may lead to better capital allocation decisions and, we believe, improved returns for investors.

In terms of structural tailwinds, several factors are expected to drive improvements in corporate performance. One example is a new program implemented by the Tokyo Stock Exchange. The program targets listed companies with low price-to-book ratios and low returns on equity, challenging them improve their efficiency or potentially face delisting from the exchange.

This should prompt companies to hyperfocus on profitability and core business strengths – ultimately leading to stronger corporate performance for Japanese companies, whilst also positioning Japan as a leading market poised for growth, compared to others across the globe.  

Ken McAtamney is a partner, portfolio manager and head of the global equity team at William Blair Investment Management. The views expressed above should not be taken as investment advice.

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