Pivot Points: Rediscovering Europe, Japan and Emerging Markets

Pivot Points: Rediscovering Europe, Japan and Emerging Markets

Anu Rajakumar: After years of US exceptionalism, early 2025 brought glimmers of European momentum with pockets of upgrades and strong sales surprises, but enthusiasm faded by late summer as revisions turned lower and policy signals grew murkier. Why did Europe's multiple-led rally prompt a reassessment, which non-US markets look compelling today? And how is the emerging markets landscape evolving across asset classes?

My name is Anu Rajakumar. Today I'm joined by Maya Bhandari, co-Chief Investment Officer of Multi-Asset and co-chair of Neuberger Berman's Asset Allocation Committee, to dig beneath the headlines and challenge some of the assumptions shaping the conversation beyond US markets. Maya, welcome to the show.

Maya Bhandari: Thank you for having me. It's an honor to be here.

Anu: Maya, let's start with the big picture. I would love to hear your highest conviction views today, and explain why now is an opportune moment for investors to really consider non-US assets.

Maya: It's an interesting time to be having this discussion, Anu, because Neuberger's Asset Allocation Committee's high conviction views, which really seek to capture opportunities 6 to 18 months ahead, skew outside the US at present, and that's pretty unusual. I'd say this is true across both equities and bonds. Perhaps a few areas to highlight at the top of our session, and we can dive deeper into areas of interest over the course of our time together.

In equities at present, we're really focused on Japan and select emerging market equities like China. We also quite like small-cap companies in the US, so it's certainly not a negative view on US companies overall, just a broad preference, I'd say for other regions. I'm oversimplifying here, but in both Japan and emerging markets, the two key drivers of equity returns.

First prospective earnings or cash flows. The second, the price we pay for those earnings or valuations, are, to our judgment, looking quite positive at the moment. I should say that we've recently shifted to at-target in Europe.

Now, in the case of Japan, and indeed, emerging markets, there's plenty more, of course, under the hood, a strong commitment to shareholder reforms in . In China, access to AI is a theme at a very different price point to the US, is a strong draw.

Good way to pull this together, I think, is that we have on our assessment move from a world of TINA, there is no alternative to the US equity market, to TERA, there are real alternatives. In 2024, for example, and candidly many a year prior, the US was frankly the only show in town. This year, returns on US stocks, particularly in unhedged dollar terms, have been frankly dwarfed by the rest of the world.

Europe, emerging markets, and increasingly, Japan. I should say something about other asset classes as a multi-asset investor. While in fixed income, having been tilted positively on the US, we have recently clipped back, taking profits, if you will, after fairly large moves. Instead, we've upgraded and turned more positive on non-US bonds, and that's true for both the governments and corporates.

Looking at all these views together, if you will, from the 20,000-foot perspective of an asset allocator, I'd say the common thread really is that every risk has attached to it, a price.

In both equities and bonds, the areas we've just discussed, Japan, select emerging markets and equities, and European, UK, and emerging market duration have, to our minds, overpriced some of those risks. For completeness, gold and indeed corners of private equity continue to have broad appeal for us as multi-asset investors.

Anu: Now, earlier you mentioned that we've downgraded the view on European equities from slightly overweight to at-target. You've also mentioned that Japan remains a standout. Tell us the thesis there. Is this a short-term tactical view, or is there more a long-term structural opportunity in Japan?

Maya: A great follow-up question. This has been, as you just reflected, one of our highest conviction views in 2025. What's changed? Now we wrote about this recently and couched it in a Kane's coat, which says when the facts change, I change my mind. What do you do, sir? We chose that because in one key area, Euro [unintelligible 00:05:14] its asset markets, the facts have on our assessment changed since earlier this year, and we vaulted our positioning in response to that. Maybe let's unpack that a little bit.

I think we all remember soaring market volatility in the immediate aftermath of "liberation day" in early April. In those dark days in early April around the announcement of pretty punitive tariffs at the time, European stocks suffered significantly ahead of global equities. I double-checked my numbers before coming on to the show. In just a week essentially, European equity shed 13%, 14% of their value in what was at the time an 11 to 12 standard deviation move.

Anu: Oh. Wow.

Maya: Now turning long European equities was on our radar at the time, and an asset we just liked got materially cheaper. We moved European stocks overweight to endorsing unhedged exposure by moving the euro in tandem. I should say just as a side point in a way that, as with many investment teams, there are broadly two reasons why we ever change our medium term asset allocation views, either assessment of fundamental investment drivers of an asset or sub-asset class shifts, or valuations or sentiment move to such a degree that a position turns more or less attractive.

As you alluded to, Anu, in your question, I think both were strongly favorable in early April, and more recently each of them have shifted in a less appealing direction. On the fundamental side, we anticipate a better growth in earnings that you just mentioned. They were lagging both stronger earnings revisions, earnings that we saw in the prior year in 2024. We doubted that the announced tariffs would be implemented in their entirety. Moreover, they were offset to a degree by some of the fiscal announcements we had coming out of the region particularly in the likes of Germany.

Now, unfortunately expected earnings this year have essentially collapsed from low double digits to zero. 2026 expectations have also started to roll over. Earnings revisions are pretty deeply negative in both absolute terms and relative terms. On balance tariff outcomes have been worse than expected, and the fiscal easing has been less than expected.

I think that the fundamental picture has weakened. Within the European equity market, we also had pretty firm positive outlook on some of the key sectors like banks. It's a hefty index sector, and we thought had significant re-rating potential to capture your point on ratings that they scaled up the return on equity curve. That happened because you've had eye watering returns from banks.

Anu: Huge, 50% to 70% that I--

Maya: It's actually 70% in Euro terms, and over 90% in dollar terms. That's three to four times what we've seen for the index and versus US banks, for example. Yet on a forward looking basis in line with broader indices, earnings growth has been pretty disappointing. Finally, valuation, sentiment, positioning, have all turned more neutral.

For example, I was looking, day before yesterday, at some of the investor flow numbers, and investor flow since April as a percentage of assets under management in European stocks, have actually been the highest since January, 2017. We've seen pretty punchy inflows despite, I would say, cracking fundamentals.

Anu: Does part of that reflect the position where you've been rebuilding the lungs and buns and gilts, and favoring higher quality credit? Are they interrelated, or what's driving some of the macro view behind the fixed income interest in Europe?

Maya: I think certainly economies are not equal to stock markets, but I'd say in tandem with that weakening earnings outlook, the fundamental outlook in Europe has also softened. Our fixed income colleagues have turned more cautious on the outlook for Europe, for example. We expect more policy rate cuts to come from the European Central Bank.

At the moment, rates markets essentially price in nothing over the next couple of years. We think you quite easily get two rate cuts in the next few months later this year and early next year. Coming back to this idea that every risk has attached to it a price, we've seen really quite substantial moves in European fixed income in bonds and gilts, in some of the spreads in Europe. That's something we sought to take advantage of.

Anu: Absolutely. Cautious on Europe, but Japan remains a standout. Tell us the thesis there. Is this a short term tactical view? Is this a more structural opportunity, and how are you expressing that in portfolios today?

Maya: I'd say in very simple terms, Japan has the combination of both really attractive fundamentals that arguably got more attractive following the recent elections, and an even more attractive price point to get exposure to these fundamentals. On the fundamental side, I'd point to rising return on equity, continued strong shareholder returns as important aspects of the investment thesis.

Japan today has the highest net share buyback proportion of the major regions. I think a strong testament to the shift that's underway and something few of us would've imagined not long ago. Earnings and especially earnings revisions are rising smartly, and so a nice positive near term outlook in addition to that positive longer term outlook in pretty sharp contrast to Europe, which we were just discussing.

I'd say post-election prospects for fiscal easing, more dovish stance from the Bank of Japan have, at the margin also added broad policy support. Coming back to the point, I've already made a couple of times every risk has attached a price, and Japanese valuations are ultra cheap however you cut it in their own right and versus global equity markets.

Anu: Great. Thank you for that. Now, bringing it all together, Maya, from a multi-asset perspective, how should investors be constructing portfolios, again, in this world of divergent policy mixes?

Maya: I know we currently have divergence, I'd say on at least three fronts, policy stances, macro and earnings set ups, and what markets are reflecting or pricing, if you will for both policy and broader macro. Perhaps, we could land on the last of these, what markets are discounting, I'd make three key points really. First, at the highest level, fixed income and equities are discounting very, very different outcomes, as they have frankly for much of this year.

We are keen to capture this in our portfolios or recommendations. Take the US for example, baskets of cyclical, relative to defensive stocks are priced very differently to 10-year US bond deals, with which they normally relate closely. This gap has started to close in the last couple of weeks as we've seen a bit of a sell off in cyclicals relative to defensives, but remains wide in an historical context.

Looking at the slope of the yield curve and earnings growth, you see a similar gap with changes in the slope between the 5 and the 30-year US bonds, for example, being consistent with very flat US earnings growth. I'm talking about over long periods. That's not the 10% to 12% that's currently the expected and indeed the run rate for US earnings.

If we roll these various elements up into broad equity premia and compare them with broad bond premia, we see gaps that we haven't really seen since the pandemic in 2020, or put differently, there's vastly more caution built into broad bond markets than there is at the moment in equities. This gap is more striking in Europe, which is where we are, if you will, actively capturing this 20,000 foot premium gap between equities and bonds and our recommendations.

As we touched on in an earlier question, long dated European bond deals, bonds, but also gilt have soared in both real and nominal terms. As we've also discussed earnings yields, essentially the inverse of a forward price to earnings, have fallen considerably. Now, we're currently long of government bonds in Europe, long of European investment grade corporate credit, where the all in yields are pretty juicy given the duration moves and against this, we are, I'd say, at best neutral on the equity market.

The second point I'd make is that we're really adopting a sharp shooting or barbell approach for allocations more generally, so areas where we really have convictions. We're long of equities in areas like Japan, select emerging markets like China. We're long of rates outside the US, Europe, the UK and emerging market, for example. We're keenly watching the earning season. That's just really kicking off for a gauge of the cash flows in equities.

I should say as well, that our only remaining short dollar position today is versus EM currency, which of course is a key component to certainly emerging market local bonds. The third, and I think very important point I'd make is that we're diversifying carefully with holdings like gold and private equity, particularly important. Diversification has been tricky this year for investors, I'd say across the piece. These are a couple of areas where we have found real opportunities. Long gold is, of course, also quite a nice way to be short dollars, but with some fundamental support to boot.

Anu: Absolutely. That was a great summary of the views. Maya, I can't let you go today without a quick bonus question. From gorilla trekking in Rwanda, to city hopping across continents, I know that you love to travel and explore our beautiful world. My question for you is, what is one must-pack item that you'd never leave home without?

Maya: That's actually a pretty easy one for me to answer because it's a great book. If nothing else, it keeps me out of trouble with my husband.

Anu: Great. Any genres that you prefer, or you gravitate towards?

Maya: I read pretty widely. Both fiction and non-fiction.

Anu: Any recommendations or recent books that you really enjoyed?

Maya: I've literally just finished, on my journey over here To Paradise by Hanya Yanagihara. I thought it was fantastic.

Anu: Good. I will mention it to my book club. Thank you very much. Thank you for sharing. To recap some of your comments, you spoke at length about the highest conviction views across regions and asset classes, tracing back from earlier this year with European optimism, to now a more sober read on earnings and policy. You shared the phrase, "We're going from TINA, there is no alternative to US assets, to TARA, there are real alternatives."

You talked about the diverging views between policy, macro, and earnings, and pricing across different regions that are really important for investors to pay attention to. Then lastly, I want to close with the cadence quote that you said, which I love, "When the facts change, I change my mind," which I think it's so important as allocators and as investors to be open-minded and flexible, because conditions do change. Being able to take advantage of opportunities is so critical, particularly in our role as multi-asset investors. Thank you so much for the comments, for the clarity, and for joining me today on Disruptive Forces.

Maya: Thank you very much for having me here.

Anu: To our listeners, if you've enjoyed what you've heard today on Disruptive Forces, you can subscribe to the show from wherever you listen to your podcasts, or you can visit our website at nb.com/disruptiveforces, where you'll find previous episodes as well as more information about our firm and offerings.

Speaker 3: This podcast contains general market commentary, general investment education, and general information about Neuberger Berman. It is for informational purposes only. Nothing here in constitutes investment, legal accounting, or tax advice, or recommendation to buy, sell, or hold a security.

This communication is not directed at any investor or category of investors, and should not be regarded as investment advice or suggestion to engage in, or refrain from any investment-related course of action. All information is current as of the date of recording, and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. This material may include estimates, outlooks, projections, and other forward-looking statements.

Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Please refer to the disclosures contained in the episode notes and episode details, which are an important part of this communication. Investing entails risks, including the possible loss of principal. Past performance is no guarantee of future results.