Global Equity Views 4Q 2017Contributor Paul Quinsee
Themes and implications from the Global Equities Investors Quarterly
- We expect the trend of increasing global corporate profits that began in mid-2016 to persist throughout 2018, with economic growth stronger, interest rates still low and capital discipline evident in most industries. Our analysts’ forecasts of double-digit earnings for 2017 and 2018 look to be on course.
- Fundamentally, this remains a good environment for equity investing, but our optimism is tempered. Higher equity valuations—and the absence of a significant market correction for quite some time—make us more cautious now.
- We still see more upside in emerging markets, Europe and Japan than in the U.S. After strong gains from growth stocks, we identify incremental opportunity in value stocks again. Across global markets, many financials still look promising, and the surprising extent of capacity reductions in many basic industrial businesses is intriguing to our investors.
- Among the potential risks we are monitoring: the unwinding of quantitative easing (QE) and its impact on capital markets; the traps of investor complacency and excessive risk-taking.
For more than a year now, a stronger, broader global growth environment has driven an acceleration in corporate profits around the world. As we approach the end of 2017, our estimates for a continued synchronized earnings recovery sustain what we would describe as our tempered optimism. We think this recovery will continue for a good while yet and are not expecting a recession (even for the now late-cycle U.S. economy) over the next couple of years. Our analysts’ forecasts of double-digit earnings for 2017 and 2018 look to be very much on course, having been supported by a wide range of positive second-quarter corporate results. As bottom-up stock pickers, we are finding ample opportunities, especially in Europe, Japan and emerging markets.
But our optimism is restrained. Higher equity valuations—and the absence of a significant market correction for quite some time—make us more cautious now. Our investors now expect average, not outsize, gains over the next 18 to 24 months. The eventual unwinding of global central bank balance sheet expansion, slated to begin with the Federal Reserve (Fed) in October, will surely present challenges. And after a strong run for global equity markets, we must guard against the trap of investor complacency and excessive risk taking.
In the following pages of our quarterly Global Equity Views, we present our investment outlook, discuss market trends and spotlight opportunities and potential risks.
Economic growth and corporate earnings
The breadth of global growth has encouraged once-skeptical investors who worried that the growth was too U.S.-centric. We now see synchronized growth and rising growth expectations across both developed and emerging markets. Purchasing Managers’ Index (PMI) readings show continued healthy levels, and in emerging markets the pace of GDP growth and the breadth of industrial production growth are increasing. Some have taken to comparing this to the old cliché of a “Goldilocks” environment. It can’t last forever, of course, but we think the not too hot, not too cold environment should prevail through 2018.
Earnings are driving markets higher (EXHIBIT 1), and we are forecasting double-digit EPS growth globally in 2017 and 2018. In the U.S., a combination of steady revenue growth, improved margins and heavy share buybacks has boosted earnings growth for several years, and we expect this to continue. However, higher debt levels will eventually constrain buybacks. In Europe, corporate profits are growing for the first time in six years, although we do acknowledge further euro strength as a potential headwind. Strong operating leverage for Japanese corporations should help propel earnings gains this year and next. In emerging markets, we project high double-digit profit growth in 2017.
So far this year, equity markets have been led by growth stocks, especially a small group of Internet companies with the market monikers BAT (Baidu, Alibaba and Tencent) and FANG (Facebook, Amazon, Netflix and Google). Some investors see a bubble forming here, drawing parallels with the extreme prices of many technology stocks in 1999. But on balance we are less concerned, given that these companies boast massive user bases, impressive growth rates and in many cases strong profitability as well. The recent rally has made them less attractive, but their valuations do not seem unreasonably high just yet. Potential regulation is the biggest risk.
Earnings growth has driven this year’s rally
EXHIBIT 1: COMPOSITION OF TOTAL RETURNS THROUGH SEPTEMBER 30, 2017
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