#Investments — 06.10.2017

Equity markets

Roger Keller

Beyond a probable lack of potential catalysts over the near term, we remain bullish over the medium term

Promising fundamentals                                                                                                       

The sales outlook for companies improves further with world growth set to continue accelerating and be synchronous; it is also broadly based, with contributions from consumption, investment spending and trade. Meanwhile, core inflation is expected to strengthen very progressively. This background should lead most central banks to remain accommodative and those looking for reducing their accommodation to proceed very slowly.

Liquidity conditions should thus not turn into headwinds. This remains an auspicious environment for equities. High single-digit earnings growth in 2018 is achievable because US companies should defend well their high margins and margin progression is likely elsewhere, thanks to operating leverage. At 16 times prospective earnings and with the price to book at 2.3, valuations already reflect positive expectations but are not extreme. They can stay well defended if rates and bond yields rise slowly and stay low over the medium term.

All in all, risk appetite should firm over the coming 12 months. Our expectation is that most of the equity market return over the next 12-15 months will come from earnings progression. Valuations are very well underpinned by the high level of macro visibility and the low level of dispersion in EPS estimates.

Not finding potential drivers in the near term

Momentum in equity markets is usually well correlated with the direction of leading indicators, of economic surprises and of earnings revisions. Leading indicators are stabilising at high levels, economic surprises are back to elevated levels and earnings revisions have deteriorated from their highest points in several years.

These classical drivers imply lack of momentum in the near future. Meanwhile, a likely upward adjustment to inflation and Fed rate hike expectations could weigh on markets. The nearing of the first Fed move to unwind its balance sheet and of tapering news from the ECB are factors that could also weigh on sentiment, as is likely the approach of China’s 19th National Congress of the Communist Party, which could bring about fears about faster growth deceleration in China in the face of accelerating reforms. At a time of complacency, as expressed by a VIX below 10, and given rich valuations, which give little room for disappointments, markets are unlikely to make much progress from here in the short term.

The window for lateral consolidation or for a move down towards the 200-day moving averages thus still remains open. In addition, a reversal in the US dollar would weigh on the US and emerging stock markets. As a result, we remain neutral short term. The technical picture supports this stance, with, for example, the weekly RSI above 70 and showing a negative divergence. We suspect that the next upward momentum will develop later in the year, when investors begin to focus on the promises of 2018.