Market Commentary

Q4 2016

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The past year was a roller-coastal ride for global markets. The start of the year was dominated
by resurgent fears of a recession in the US, with inevitable international repercussions. This triggered a dramatic plunge in sentiment worldwide, manifesting itself in tumbling equity prices. The MSCI World index crashed by almost 12% in the first six weeks [CHART 1], causing several major markets to collapse deep into bear market territory. From their April 2015 highs, emerging markets ended their slide 36% down, Europe 27% down and the world market 19% lower. While the recession calls proved wildly exaggerated, the growth concerns were largely vindicated as the US GDP rate almost halved from 2.6% to an estimated 1.6% in 2016 [CHART 2]. Global growth also slowed, but not as sharply, largely due to unchanged growth in China.

However, there were some positive developments despite the decelerating growth: the US unemployment rate fell from 5.3% to 4.9%, Europe (with unprecedented monetary stimulus) managed to avoid further weakness, and fears of a property-driven slowdown in China proved unfounded.

Looking ahead to 2017, the recent flow of macro data indicates that the positive 8-year old US business cycle remains intact and is actually
gathering some momentum. Globally, with prospects of slightly more expansionary fiscal policies and continuing relatively easy monetary conditions, an acceleration in the pace of growth this year appears likely. However, this will probably still remain below trend.

The Trump presidency could, however, have a significant impact given the wide range of possible policy outcomes. While his massive stimulus proposals are potentially constructive, these require approval by a still fiscally conservative Congress.  His anti-globalisation initiatives (punitive import tariffs and withdrawing from established trade agreements) could, on the other hand, prove a significant headwind to the expected global upturn. These latter initiatives are less likely to be approved by Congress than his huge infrastructure spending proposals. The consensus forecast for the US, amid all this uncertainty, is for a pick-up in growth from 1.6% to 2.2% in 2017.  Global GDP is forecast to rise from 3.0% to 3.4%.

Against this backdrop the outlook for earnings obviously also improves.  Indeed, the consensus among analysts is that global earnings will rise by 12.6% from 2016’s meagre 1.8% [CHART 3].  However, we believe analysts are too optimistic given the very modest uptick in GDP forecasts.  Downward revisions over the course of the year appear inevitable.

There are, of course, several positives driving these aggressive estimates: the energy and mining sectors are likely to rebound strongly, and share buybacks (particularly in the US where easier repatriation of offshore funds seems likely) should increase to record levels boosting per share earnings. And, if tax rates are sharply reduced by the Trump administration, US earnings will enjoy a sharp one-off kicker. Negative influences include the strong dollar and rising interest rates.

What then is the possible outcome for global equities? The expectations of a pro-growth policy under the Trump administration (despite the many uncertainties) should help the US market to advance further, but the implications for emerging markets are less certain.

Equity valuations around the globe remain stretched. The forward p/e in the US is 18.8 vs its 10 year median of 15.3 and elsewhere the premiums are similarly elevated (Europe 14.7 vs 13.0; China 13.5 vs 10.9 and emerging markets 13.5 vs 11.9) [CHART 4].  However, as was the case in 2016, both cash and bonds remain decidedly unattractive alternatives.  Indeed, with inflation pressures finally increasing and interest rates having bottomed, the risk of capital loss in bonds has become more focused. This suggests that equities could sustain their elevated ratings, but further p/e expansion seems improbable.  Market growth should therefore be limited, at best, to the rate of advance in earnings.

Given our view that the consensus 12% earnings growth is optimistic we think an improvement in the order of 6-7% in 2017 is a more realistic objective.