Global Equity Views 1Q 2019Contributor Paul Quinsee
Themes and implications from the Global Equities Investors Quarterly
- After a year of weak returns and an environment in which traditional style factors underperformed, many of our investors now see an above-average level of opportunity across areas of global stock markets.
- While earnings forecasts are coming down across the globe, revisions are modest in magnitude so far. Profits are still growing, and the modest deterioration in expectations has, in our view, been more than offset by the large drop in stock prices since October.
- Our Value team is finally seeing more constructive opportunities, including investing in financials and small caps; our emerging markets investors are expecting improved returns ahead after a difficult year for the region, though much depends on China.
- We continue to believe that trade tensions and tariffs pose the main risk to equity markets, and in the U.S. very high margins and rising corporate debt levels pose a potential risk.
What a difference a quarter has made. When our equity investors met in late September, the mood of the group was more subdued than usual, and when asked about likely equity market returns over the next 18–24 months, “below average” was the most popular response. Two concerns were weigh¬ing on us: first, the risks to profits growth posed by higher interest rates and growing trade frictions, and second, signs of froth in the technology sector, which had been leading the markets higher.
Three months later, we are again feeling better about the outlook for equities, and we also see some interesting opportunities to add value within markets. True, the prospects for corporate profits growth have been fading and earnings forecasts have been slipping around the world. But profits are still increasing, and the modest deterioration in the outlook is, in our minds, more than offset by the significant drop in stock prices since early October. When that decline is set against the backdrop of reasonable growth, it takes equity valuations to a much more interesting place for longer-term investors. If 2018 began with complacency and even euphoria, the year ended on a very pessimistic note, and we think this dramatic shift in mood has created opportunities (EXHIBIT 1). Growth stocks have been as hard-hit as markets overall and look much less frothy these days, although the bigger opportunity may well be ahead for value investors, with the gap between the two styles still at historically very wide levels. And international markets have finally started to perform better on a relative basis. At the time of writing, markets have quickly recovered almost a third of the ground lost in Q4, but the risk-reward picture still looks better to us than it did back in September.
The world is, of course, not free of worry, and we do think that profit expectations are still a little too optimistic in the near term. In the technology sector, for example, the semiconductor cycle has rolled over, and the trend toward longer smartphone replacement cycles is becoming more obvious, although, importantly, enterprise technology spending is still robust. In the energy sector, market expectations haven’t yet caught up with the dramatic collapse in oil prices during the second half of the year. More broadly, with global growth cooling down and inventories built up last year in anticipation of tariff increases, business will be slow for many industrial companies in 2019. But we think enough bad news is now discounted for investors to start thinking about what could go right. Modest interest rate increases and healthy consumer demand could prolong the U.S. economic cycle for some time to come. Most importantly for us, our work suggests that the level of opportunity in many areas of the global equity market is now clearly above average.
Profits growth will clearly decelerate this year, and market expectations are probably still too high, but we don’t see a meaningful downturn developing any time soon. This year looks to be one of mid-single-digit profits growth globally, with the U.S. once again outperforming the global average, but by less than during 2018. Looking out beyond 2019, our research indicates that profits are now modestly above trend in the more cyclical sectors, including industrial/commodities, automobiles and parts of technology. As a result, profit declines in these groups should be expected (and, indeed, current low multiples suggest that they are).
EXHIBIT 2 presents a snapshot of our outlook.
In 2018 earnings grew, but lower multiples led to negative
EXHIBIT 1: In 2018 earnings grew, but lower multiples led to negative
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