Equities: Why Markets Are Expected To Mark a Pause in the Coming Months
Recent macroeconomic figures have demonstrated that the economy is in good shape in developed economies. Corporate earnings have reflected this trend with positive earnings surprises and better revenues in 4Q16.
In this environment, the stock market has beaten most investor expectations by rallying strongly. Investors have massively played the reflation trade. The markets have interpreted the hikes in policy rates as confirmation for the reflation trade. Banks have thus done extremely well, keeping US equity markets close to record highs. Pro-cyclical sectors have outperformed while Energy and Telecoms have underperformed meaningfully. Some local stock indices (e.g. S&P500 index, Dow Jones index) have reached new records. Understandably, this raises the question about where investors should go from here.
At this stage, we do not radically change our sector recommendations, but the markets are expected to mark a pause in the coming months. The rationale is as follows:
- The markets have already priced in a lot of fundamental positives. Valuations now seem high in some markets (in the US in particular). When we look at the different scenarios for growth, inflation and interest rates, it appears that equity markets are broadly priced for perfection. A risk of disappointment thus exists.
- In the US, Trump’s general policy presents opportunities but also poses risks: the plan for higher infrastructure spending and larger tax cuts should support growth whereas protectionism fears are expected to weigh on international trade. President Trump is in favour of a new tax on imports. This reform is expected to be twofold: firstly, a tax on imports and a tax credit for export revenues; secondly, a decrease in the corporate tax rate. It is a heated debate in the US.
- In Europe, political uncertainties will persist in the coming months due to the packed electoral agenda. The possibility of a National Front victory in France’s presidential election (first round on 23 April), as well as uncertainty about which candidates will make it to the second round, continue to weigh on European stock markets. Interest rates have eased slightly, but the yield spread to Germany has risen in some European countries.
Overbought conditions and complacency are making the markets vulnerable to political fears. As a result, we recommend reducing exposure to value and cyclical stocks over the coming months.