We see regional strategy becoming more relevant, with regional dispersion in its 96th percentile.

Macroeconomic backdrop/scorecard: Higher bond yields driven by higher US inflation expectations, IP accelerates despite PMIs falling with well above-trend growth in 2022, value outperforms in Europe and the US dollar looks close to the end of a bear-market rally. With these factors combined, our composite scorecard most favours Continental Europe and GEM.

Continental Europe remains our key overweight: 1) Macro: It is the only region where CS is above consensus for GDP in 2021 and 2022 – PMI momentum is much better than in the US, and markets have unusually decoupled from this. Rising inflation expectations/bond yields usually lead Europe to outperform. Europe has less labour backlog (or wage problems) than other regions. 2) Excess liquidity is the highest of any region as the ECB continues to expand its balance sheet more than anywhere else. 3) Valuation attractive (P/E 18% discount to US; actual ERP is 8.1% cf 6.5% warranted). 4) Positioning remains cautious. Strategically, Europe is well positioned because: it has structurally easier fiscal and monetary policy; the Eurosceptic parties’ popularity has fallen sharply; and Europe is dominant in green/sustainable companies (8% of market cap). We prefer Spain and Italy over Germany. Our ‘Top of the Crop’ ideas include BASF, Brenntag, Logitech, Schneider, SocGen and Smurfit Kappa.

GEM (ex-China)—raise to small overweight: GEM benefit from a weaker US dollar, rising inflation expectations and China PMIs now being close to lows (and China close to an easing cycle). China credit impulse leads GEM performance by six months. Equity and currency valuations (ex-China) are both close to 15-year lows. GEM equities have abnormally lagged behind GEM bonds (market-cap weighted). GEM risk appetite is 2std below its norm. We are benchmark China, but see much of the negative news priced in (P/E 27% discount to global markets). We particularly like India (our long-standing structural overweight), Mexico and South Korea and upgrade Taiwan to overweight.

UK—remain overweight: UK performance is more closely tied to value outperforming than any other region, and we think value outperforms in Europe. Valuations are extreme. Fiscal fundamentals are the best outside of Germany in the G7. The UK (along with Spain) has the highest catch-up potential in terms of GDP. The issue is likely sterling strength; therefore, we would be more overweight unhedged. We like domestic UK (M&S, Bellway). We see Unilever, Asos and Elementis also looking abnormally cheap versus their international peers.

Japan down to benchmark: Although most of this year’s headwinds are behind us (slowing China, falling TIPS, sharply rising oil, delayed vaccinations), we see nothing further compelling in Japan (valuation, corporate change, funds flow) at a time when the macro backdrop is not clearly supportive (Japan has the highest operational leverage to rising IP momentum, but we think global PMIs are likely to fall and the dollar weaken).

US—small underweight: The US tends to be the worst-performing region when the cost of high-yield debt rises (having relied on leverage more than any other region). It has the lowest operational leverage and therefore underperforms when non-US IP accelerates to be less above 3%. We are only a small overweight of tech (the US outperforms 70% of the time tech outperforms). Tax and regulation risk seem higher than in Europe or Japan. Valuations are extreme (ex TMT). The US comes bottom on our composite and our macro factor scorecards.