Following a difficult autumn, investors are likely to be weighing whether 2018’s risks are almost in the rear-view mirror. Brexit could conceivably be settled by January, with minor changes to the Withdrawal Agreement; the Italian budget stand-off could be resolved by a telephone call. In terms of financial conditions, the Fed may raise rates in December but could guide to a pause, reflecting economic or market turbulence. Similarly, the ECB could acknowledge that the weakening trend in eurozone data warrants a continuation of QE, or at least some very doveish forward guidance. Finally, following the mid-term elections, rebel Trump’s politically motivated trade war on China is now without a cause, at least in the short-term. Speculation of a US/China trade “deal” at the upcoming G20 meeting in Argentina is rising, which could perhaps at least represent a cease-fire in hostilities. Such a shift in sentiment may seem far-fetched, but should at least be considered alongside more bearish scenarios.
Taken together, and in the context of current consensus earnings growth forecasts for 2019 of approximately 10% globally, the market could, in this intentionally rosy scenario, be set for a rally. However, the fly in the ointment is the meaningful slowdown in economic survey data outside the US in recent months, combined with the large decline in the oil price over the last 6 weeks means that earnings forecasts remain at risk.
November’s flash manufacturing PMI for Germany and for the eurozone overall indicates growth has stalled over the summer, with the current eurozone reading of just above 50 consistent with only pedestrian growth over the final quarter. There may be a one-off impact of new regulations within the auto sector but the slowdown appears to be broadly based.
Similarly, business optimism in China, Germany, Japan and the UK is on a declining trend. Global trade fears may be partly to blame but for investors the data is consistent with weakened earnings momentum over coming months and increased profit warning risk in energy and cyclicals, rather than a bounce in markets.
In these same surveys, inflation pressure has been sustained, despite the perceived slowdown in end-demand. The data therefore makes for mixed reading for central bank policymakers, who in the US at least appear for now to be more focused on normalising policy. The ECB has been tight-lipped about the end of QE but the data raises real questions about the strength of the eurozone recovery in our view.
With market valuations outside the US easing from the extended levels of 2017, the investment outlook remains difficult to read. Notable political risks are seemingly directly ahead, yet the (negative) outcomes are still not certain and these events are at least in part discounted by the market. On balance, earnings risk keeps our cautious view on global equities in place. We are mindful of the 2015 experience where the resources and energy sectors continued to decline despite attractive valuations, until earnings forecasts stabilised. We can also see the relative merits of a risk-free 3% annual return on US 2y Treasury notes in the circumstances.