PARTNER INSIGHT: Following strong equity gains and rising valuations in recent years, Jeremy Podger questions whether global markets might be recalibrating for a new era of earnings growth
In 2017, equity markets produced very strong returns with the MSCI All Country World index up 24.0% (total returns) in US dollar terms. While the US lagged a little, continental European markets were helped by a strong euro; and emerging markets were up 37.3% (though virtually unchanged on their level seven years ago).
The US's dominance (in performance terms) since the financial crises has partly been due to a currency effect, but also reflects the fact corporate profit growth has been relatively strong in the US and relatively weak elsewhere (see chart, right). Overall, as the world saw no earnings growth (in US dollar terms) between 2013 and 2017 - it was thus a ‘revaluation' phase for markets. In 2017, however, the rate of global earnings growth was broadly similar to the rise in markets - so we could say that we appear to be in a new ‘earnings driven' phase of market growth.
At the end of December 2017, the consensus view expected US earnings to grow a further 12.6% in 2018, with the passage of the tax reform bill now propelling this number into the high teens (in percentage terms). There may also be scope to surprise positively outside the US as well. So this should be supportive of markets this year, though one should note that growth in 2018 (and 2019) is unlikely to be up to last year's strong showing.
Against this is the expectation of a tightening of liquidity conditions with further rate rises in the US, and some ‘tapering' of quantitative easing in Europe. Meanwhile, economic indicators are generally very positive (though admittedly one could worry they cannot get much better). What do these potentially opposing forces add up to? More market volatility than the unnatural calm that prevailed in 2017, that is certain!
Looking at market levels, it is difficult to deny that low bond yields have had some influence in dragging up equity market valuations in recent years. While investor sentiment in the US among private investors has been positive recently (though less so amongst professional investors), data shows actual fund flows in the US have been more directed to bonds than equities since the financial crisis.
It has been a similar picture for other regions, suggesting it is at least possible that with fixed income yield spreads now very compressed, investors could deploy more risk capital into equities in general in the coming year. Thus, at this stage I am inclined to be generally positively disposed towards Europe, Japan and other Asian markets. I am a little more cautious on the US, despite the recent boost from tax reform.
For more insight into where earnings growth is heading in 2018, read the full Spotlight on Global Equities guide here.
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