#Market Strategy — 19.06.2018

Equity Markets: No End In Sight For The Current Bull Market

Roger Keller

Equity markets are mainly driven by two factors: earnings and valuations, with the former expected to be the prime drivers in 2018. In the near term, the road is likely to remain bumpy.

Risk of a volatile and hot summer

With the earnings season now behind us, investors will turn to macro data to find potential catalysts. Given that macro indicators should confirm that growth is slowing down and inflation is rising, a positive momentum is unlikely in the coming months. In addition, upward pressure on bond yields and a trend towards less monetary accommodation represent headwinds. Meanwhile, political uncertainties abound and several of them are elevated (global trade tensions in particular). Hence, volatility is likely to prevail for a while.

Medium-term fundamentals remain solid

Global economic growth is broad-based. Moreover, there are no signs of economic excesses that could lead to a recession. Indicators, such as the yield curve, confirm that it is too early to worry about such eventuality. In truth, visibility is good and consensus earnings estimates have been revised up by 1.5% on the MSCI World AC index for the next 12 months. The consequence is an expected earnings growth rate of 11.9%, which is very appreciable at this stage of the cycle. This positive earnings outlook is the key reason to believe that markets will be higher in the medium term.

Valuations set to remain stable

Valuations are not a constraint. They are either in line with long-term averages (between a 12-month forward PE of 15x and a price-to-book of 2.2) or attractive with a dividend yield of 2.4% and a still large risk premium, although the latter benefits from expensive bonds. Because of expected increases in bond yields, valuations are unlikely to expand. In other words, the 12-month outlook for stocks is closely aligned with the growth rate of earnings, still placing equities in an attractive light.

An environment for bottom fishing

We are directionally positive over the next 6 to 12 months thanks to the rising trend in earnings. Meanwhile, we expect choppy markets, a stance supported by technical and sentiment analysis. This is an ideal environment for active investment management. The majority of investors though do not believe in market timing and favour investing based on fundamentals. They should thus be ready to cope with a bumpy ride—while keeping a close eye on the probabilities of extreme tail risks—and take advantage of volatility to invest in pro-cyclical markets and sectors.

Bottom line

The current bull market is one of the longest in history. The end is still not in sight thanks to the prospect of a continued rise in earnings this year and next. However, the path is expected to be bumpy in the near term as positive catalysts are likely to take time to materialise.