The expert magazine of Ostrum AM

The world equity markets wiped out the losses suffered in the fourth quarter of 2018 much more quickly than expected, with the strong rebound driven primarily by the shift in policies from the main central banks i.e. Fed, ECB and PBoC.

Perception of excessive liquidity thereby pushed up valuations, and in the US, the S&P is currently trading less than 5% from its all-time highs, while Europe has surged more than 10% in 2019 so far
and China has soared 24%, although the extent of gains reflects a reweighting of this market in global indices. A number of questions remain on the sustainability of this stockmarket rally and we have already hit our end-ofyear targets in March. Price-to-earnings multiples are rising, despite a drop in earnings growth projections. Meanwhile, volatility looks artificially low given the large number of political and economic risks – Brexit primarily – and out of kilter with current uncertainty on the economic costs of the UK’s exit from the EU. Sluggish volumes also make it difficult to   fully confirm this self-fulfilling and indiscriminate trend and the extent of the upswing is unusual.

Volatility looks artificially low given the large number of political and economic risks – Brexit primarily – and out of kilter with current uncertainty on the economic costs of the UK’s exit from the EU.

The worst is never sure


Low volumes over the past six months probably reflect certain active investor groups’ (hedge funds, CTAs: systematic strategies) clear underexposure to the asset class. These market operators are not structural buyers, but they contribute to market liquidity and the formation of prices. However, apart from positioning requests, derivative exposure for traditional fund managers and hedge funds does not point to significant excesses. The equity markets have therefore probably been in something of a vacuum and available cash will be re-allotted as political and economic uncertainty eases. Rising commodities as well as increasing prices for sea freight over recent weeks remind us that that the worst is never completely sure. Looking to European institutional investors, weak bond yields dent returns for bond portfolios, while strong equity dividend yield (3.35% in Europe) is only on offer on the high yield segment at this stage. However, a catalyst is still required to consolidate share prices and reverse the allocation trend into bonds.

In Europe, defensive sectors began to outperform again after cyclicals’ attempt to stage a rebound was hard hit by sluggish economic indicators. In our view, this looks more in line with the macroeconomic cycle situation. Expected 12-month EPS growth on European equities stands at around 7%. Low interest rates have major implications for different sectors, with banks’ profitability dented again. The new TLTRO programs look less generous, and this situation is set to be a hindrance for banks’ share prices in peripheral countries. Consolidation in the banking sector remains a priority. Meanwhile, the automotive sector also faces a threefold threat with major technological change, the consumption cycle running out of steam, and various governance problems. Weak valuations cannot prop up this sector forever.

So after a shift in tone from the central banks, stockmarket gains in 2019 can only continue if the economic cycle stabilizes.

Political uncertainties still a drag

 

The 1Q 2019 earnings reporting season will kick off from mid-April onwards in the US, and analysts anticipate EPS consolidation, although aggregate operating margins for S&P 500 companies are expected to improve slightly. However, the accretive impact of share buybacks and M&A has been dwindling for the past several months, as these moves have decreased with pressure on credit spreads in 4Q 2018. Marginal share buyers (companies themselves) are now less present. Looking to individual sectors, banks are hampered by inversion of the yield curve, while the healthcare sector is also suffering a performance lag. The quest for growth is becoming a priority again or US shareholders, and this trend will continue to underpin tech stocks, especially equipment manufacturers. On the emerging markets, China is fueled by investors’ forced buying as they track indices. However, valuations are not excessive at close to 11x 2019 earnings. Meanwhile, a trade agreement with the US would drive prices up. The re-emergence of political risk in Brazil and even Turkey warrants a discount after a sound trend at the start of the year. So after a shift in tone from the central banks, stockmarket gains in 2019 can only continue if the economic cycle stabilizes, which will require an end to uncertainty on trade conflicts and Brexit. However, valuations keep downside in check.

Horizons Q2 -2019 - EN

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