While our concerns on valuation remain in place, in the short-term market performance is more closely linked to the trend in forecasts profits. Those looking for a reason to sell equities on this basis are likely to be disappointed. As we approach the half-year point, median earnings growth forecasts for the US remain robust at 18% while eurozone and UK equities are at 8%. For now, our base case remains that the benign derating – equities moving sideways while interest rates and profits increase – will continue.
Despite a meaningful decline in economic momentum in the eurozone and UK, there has been little impact on earnings forecasts to date. In the past, our earnings revisions indices have led the economic data. Robust forecasts therefore tentatively indicate that Q1’s economic performance may be temporary with limited impact on the full year outlook. This would also correspond to the current views expressed by monetary policymakers.
Positive earnings revisions have been led by large-cap energy sector. This explains why the weighted average earnings revision index shown in Exhibit 2 has been moving higher, even as the median forecast in Europe and the UK has moved only sideways during the past month. Trump’s recent announcement withdrawing from the Joint Comprehensive Plan of Action on Iran and re-imposition of sanctions is likely to maintain the momentum in the near-term, even if oil prices are approaching levels which have proved unsustainable in the past.
European and UK estimates have not had the one-off boost from tax reform and have also until very recently been pressured by a rising exchange rate. The turn in the US dollar which was in our view only a matter of time given widening differentials in economic performance between the US and Europe is likely to benefit European export sectors even if it is too early to show in the data. However, should the dollar strengthen too fast, investors should also be alert to the building pressures on emerging markets from dollar strength and rising US interest rates.
We continue to take a cautious view on developed market equities due to the likelihood in our view that market indices will struggle to make headway as interest rates and bond yields return to more normal levels, rather than a belief that any sharp falls are imminent. A benign de-rating process is clearly much easier to achieve when profits growth is as strong as it is now.