#Investments — 31.10.2018

The Equity Markets: The Depressed Sentiment Is Poles Apart From Economic Fundamentals

Roger Keller


Three fears dominate the scene. They concern the extent of 1) future rate hikes and rises in bond yields 2) the slowdown in growth and earnings in 2019 and 3) the negative impact of various political uncertainties. These fears are exaggerated in view of fundamental trends, which remain favourable. Good buy opportunities are emerging, but the ramp-up of a positive momentum will take a while to materialise. Our preferences remain pro-cyclical sectors.

October was faithful to its reputation

October is about to end with the sad prospect of delivering the worst monthly performance since October 2008. If confirmed, it will have been the worst month in this bull market (which began in March 2009). When the markets closed on Friday evening, the MSCI World All Countries index had lost 9.4% during the period under review. Stripping out the US, where the S&P 500 shed 8.8%, the index fell by 10%. Year-to-date, the global index lost 7.4%, broken down as follows: -0.6% for the United States and -14.7% for the rest of the world, which was penalised by a negative currency effect of 4.8%.

Investor fears concern the negative impact of:

  • rate hikes and rising bond yields ;
  • various political tensions ;
  • a weaker earnings momentum.

The reporting season is not giving a worrying message; on the contrary

In the US, earnings growth has exceeded the peak, judging from the results published by nearly half of listed companies: after a progression of 25.4% in the second quarter, earnings growth is expected to decelerate in the coming quarters. It should slow from 23.7% in the third quarter to successively 17.6%, 7.8% and 7.2% before rising to 10% in the third quarter of 2019.

In the eurozone, a little more than one-third of companies have published their results. Despite some nasty surprises, a timid improvement in earnings has been seen, a trend expected to continue in the coming quarters. The consensus is for an acceleration from 6.3% in 2018 to 10.4% in 2019.

The overall landscape is further earnings growth in 2019, albeit at a more moderate pace, slowing from 15.7% in 2018 to 9.9% in 2019. Among the factors weighing on the earnings momentum, we highlight first of all the fading positive impact of tax cuts in the United States, secondly the consequences of the introduction of tariffs linked to the trade war between the United States and the rest of the world, thirdly the pressure on margins due to wage growth and higher interest expenses, and finally, the disappearance of positive base effects in some sectors such as Energy and Basic Materials. However, nothing justifies the current market stress. Far from it!  Even if earnings were to grow by only 5-7% in 2019, the implications remain positive for stock markets as current valuations are in line with long-term averages.

The overall environment will remain supportive after the triple peaks of 2018

As we do not expect trade tensions to drag the global economy into recession, earnings will remain on a growth track thanks to solid underlying trends in consumer and investment demand and favourable government policies. Furthermore, in view of our scenario of modest rate hikes and small rises in bond yields combined with the political uncertainties disappearing gradually, the current gloominess in the markets seems overdone: investor sentiment appears de-correlated from economic and company fundamentals.

2018 is definitely a year of triple peaks: a peak in economic growth, a peak in global profit growth and a peak in global liquidity, reflected in the reduction of main central banks’ balance sheets. These are characteristics of late phases in the cycle, and these phases are usually accompanied by higher volatility. But what counts most is that we are not yet at the end of the cycle. There are no classic signs of excess (stocks, capacity utilisation rates, wages, etc.). We do not think 2018 will be the peak year for equity markets. On the other hand, this year marks the return of higher volatility. Thus, good investment opportunities are emerging.

It will take time for the conditions necessary for a rally in stock markets to be established

Although the general backdrop is supportive, the catalysts for a rise in equities will take time to materialise. Let's consider the leading indicators. They are not yet in a stabilisation phase; in other words, economic data scheduled for release in the coming weeks will continue to fuel investor concerns about the extent of the future slowdown.

Meanwhile, various political uncertainties (results of the US mid-term elections, Italian budget negotiations) should disappear.

Thus we expect a gradually brightening outlook for investors.

From a technical viewpoint, we see no capitulation signs yet. For example, the gap between bulls and bears remains small and the VIX, a volatility indicator, has not yet reached the levels that are traditionally associated with buy signals.


In our view, investor jitters are overdone in view of economic fundamentals.  This difference between perception and reality provides a window of opportunity to buy shares at attractive conditions.  Do not expect to see the return of a positive momentum straight away; patience is the name of the game, because investor fears can only disappear gradually. We continue to prefer pro-cyclical stocks.