December 2013 Equity Investment Outlook
Fundamentals Update as at 28 November 2013 by Lorenzo Beriozza
Risk assets have risen further over the course of November, as political wrangling over the economy in the US has receded in the rearview mirror, while economic data has been encouraging and the US third quarter earnings season has come in much better than many had feared.
Expectations for US monetary policy continue to dominate markets, and the likelihood of a start to the tapering of asset purchases relatively soon has been increasing on the back of good economic data – most importantly a much-better-than-feared October labour market report – as well as recent communications by the Federal Reserve themselves.
While a December start still looks a little early, it is not completely out of the question. However, these policy considerations have not stopped developed market equities from rising strongly. The Japanese Topix index has risen by 4.9% month-to date, while the S&P500 index is up by 2.6% and continues to make new all-time highs, with Europe roughly flat and the performance laggard for now.
It seems the combination of an improving growth outlook, and the increasing acceptance that monetary policy in developed economies will remain very loose despite tapering, is helping these markets largely to shrug off tapering fears.
The same cannot be said about emerging markets, where Fed tapering is likely to exacerbate cyclical economic challenges. Despite the renewed excitement around the Chinese economy following the recent reform proposals, the MSCI emerging market equity index is down by 2.3% in November, under-performing the MSCI developed index by 3.5%. Emerging markets equities have now nearly given up all of their outperformance between July and October.
The view for continued rises in risk assets is justified on the basis of three drivers:
- Accommodative central bank policy. Central bank balance sheets will continue to grow substantially well into 2014 – the eventual onset of Fed tapering not-withstanding. Tighter US policy at the margin may also lead to further monetary policy activism in Japan and Europe, as central banks try to offset spill-over into their own local monetary conditions, and the recent rate cut by the ECB and murmurings about further unconventional steps such as negative deposit rates are early signs of this.
- Attractive risk asset valuations. Equities continue to look cheap relative to bonds, and even ignoring the low level of bond yields, on their own terms they look no worse than average relative to history on measures such as price-to-book (P/B) or cyclically-adjusted price to earnings (P/E) ratios – although this varies by region. In credit, high yield spreads have re-tightened but still offer decent value given good fundamentals.
- Stronger global growth. The global economy continues to accelerate, and unusually this is led by developed economies. The US is showing resilience in the face of political shocks and is likely to grow above trend in 2014. Europe has emerged from its protracted recession, and while growth remains uneven and the pace of growth has weakened in much of the region over the past two months, forward looking data still suggests the region should show growth close to trend next year. Meanwhile, the Japanese economy continues to pick up in the wake of policy stimulus. Things look less rosy in the emerging world, but at least, the Chinese economy has stabilised for now. The reform proposals coming out of the Third Plenum in China are also igniting some optimism about the medium-term growth outlook, although the near-term impact is far from clear.Nevertheless, widespread cyclical challenges remain present in emerging economies.
Earnings growth seems to be bottoming across regions – this is evident in the trailing data, and there are first signs of it in US forecasts for 2013, which have begun to rise post the Q3 earnings season, although they are still weakening elsewhere. Earnings revisions (the ratio of analyst EPS upgrades to downgrades) have so far failed to improve convincingly, although the US ratio, at least, remains near the neutral 1.0 level. Leading indicators of earnings growth continue to point to strength ahead, and consensus forecasts will likely need to be revised upwards in coming months.
Source: J.P. Morgan
