Market Review July 2018: Is the sun set to shine on the Equity markets?
July was a month where the negative headlines seemed to take a back seat as a wave of positivity and optimism swept the nation; comparisons were being drawn between the recent weather and the scorching summer of 1976, the three lions finally reconnected with the public and Geraint Thomas became the third Briton to win the Tour de France.
So the question is, can the positivity resurrect investors animal spirit and provide a much needed injection of confidence into the equity markets?
Whilst the answer to the question may not be clear cut, the early signs are positive with several key indicators appearing to support a return to a risk-on environment.
Firstly, it makes sense to concentrate domestically and address the news that the BoE has decided to raise interest rates above 0.50% to 0.75% for the first time in almost a decade.
From a headline perspective, this may appear another setback for the domestic equity market as stock markets don’t tend to like higher interest rates as it increases the return you can get from leaving your money in the bank, making risk taking in the stock market relatively less attractive.
However, in this instance, the market has appeared to absorb the news and remain resilient with both sterling and the FTSE little changed. This implies that the market had largely priced in the rise and therefore any negative reaction is expected to be somewhat muted. In fact, the show of confidence from the Bank could create more optimism around UK domestic stocks.
Moving a little further afield, European PMI, an indicator of economic health for manufacturing and service sectors climbed month on month as investors became more comfortable with holding risk. In addition, strong US earnings and US GDP rising at its highest level since 2014 fuelled the flames of optimism.
These are undoubtedly powerful drivers for equity markets, and for now at least, the prospect of higher interest rates in the US and a potential end to QE in Japan, is not phasing markets.
The main area which could benefit the most from the uptick in sentiment appears to be the Eurozone. So far, the European market has had a torrid year with only the Cac 40 and the FTSE 100 showing positive returns in 2018, compared to a 7% gain for the S&P 500 and a 15% gain for the tech-heavy Nasdaq.
The case for the European market to finish the year on a positive note is driven by three factors :
- Growth: A strong US growth rate could ease Trump’s trade war rhetoric, which may benefit the export heavy European indices, especially the Dax. Added to this, stronger growth in the US is starting to spread which could benefit the Eurozone’s economy in the coming months.
- Politics: Trump’s recent meeting with European Commissioner Jean-Claude Juncker went a long way to diffusing the transatlantic trade tensions as the US President declared the meeting “a very big day for free and fair trade”. With the fear of Europe being caught up in the cross-fire of the US-China trade war appearing to be contained, the chances of a strong bounce back after a weak performance for most of the year seems a realistic possibility.
- Relative value: Last, but definitely not least, the European indices are looking cheap in comparison to their US counterparts. The P/E ratio for the S&P 500 is 21.09 and 27.97 for the Nasdaq, compared to 15.89 for the Eurostoxx 600 and 14.16 for the Dax. Dividend yields are also looking more attractive in Europe, with the average yield on the Eurostoxx 600 at 3.53%, vs. 1.84% for the S&P 500.
With the developed markets showing signs of gathering pace again, a compelling case also seems to be presenting itself for Emerging Markets. Just like European equities, Emerging Market equities have struggled since January and are 15% off their January high as trade concerns added to the currency, interest rate, and policy turbulence within the region to destabilise the equity and currency markets. Yet an argument could now be made that although the risks still remain, current valuations and improving earnings growth in the region now offer ample compensation for these risks as a clear disconnect between prices and fundamentals emerges.
To illustrate this further, equity valuations are currently around 11 times forward earnings, just below their five-year average, whilst estimates for forward EPS growth for both 2018 and 2019 have recently been revised upwards and are now running well ahead of the average over the same period.
Despite the possibility of further consolidation in the near term, emerging markets equity fundamentals remain intact, implying the outlook for EM stocks may be brighter than current valuations suggest.
With increasing signs that global synchronised growth and low inflation is expected to continue; the global economies “goldilocks moment” looks set to remain, with the current environment appearing just right to support the high equity valuations, tight credit spreads and generally low levels of volatility.
However, If we have learned anything from the #itscominghome brigade of the past several weeks, it would be that cautious optimism rather than over exuberance may be the most sensible approach as we plan our route through to the end of 2018.
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