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#Investments — 07.06.2017

Part 1. Stock market outlook

Roger Keller

The lines here below represent Part 1 of our views on stock markets. The focus is on their directional prospects over the coming 12 months. In Part 2, we delve into the relative merits of the following six stock markets: the US, the euro area, Japan, the UK, the Swiss and emerging markets. The message that comes out from both parts is that, after a period of consolidation, stock markets should be able to reach new highs, under the leadership of pro-cyclical markets.

Most of the 2017 expected gains have already been achieved

The trifecta of strong composite leading indicators, positive economic surprises reaching historically very high levels and earnings revisions returning into positive territory for the first time since 2011 allowed stock markets to register solid gains since the start of the year. Our expectation for 2017 was for markets progressing in line with the growth rate in earnings, as valuations usually stay stable at best within the context of a rising Fed funds rate. We continue to expect global earnings growth of 10% for 2017; the MSCI World All Country index is already up by 10%, helped - it must be emphasised - by a 5% decline in the US dollar for the part of the index that is based on other currencies, as the latter is calculated in dollars. Does it mean that equity markets have reached their high point for the year? For some time… probably. However, by the end of the year we believe that higher levels will be seen, with investors peering at a positive outlook for 2018, for the first part at least. In coming months, a period of consolidation is our core scenario. We are thus neutral over the near term but remain positive for the medium term.

Air is getting thinner

This year’s key drivers have lost impetus: leading indicators have stabilised at high levels, economic surprises have deteriorated and earnings momentum has seen its best as the maximum impact of the recovery in the oil price was expected for the first quarter. Now, new drivers are not on the horizon as pro-growth policies in the US will take time to materialise and are likely to be much more limited than hoped by many investors and inflationary pressures are slow to build. Meanwhile, signs of growth deceleration in China will become more visible. When one adds overbought conditions, signs of complacency and warning signs from other technical indicators (RSI, MACD,…), the outlook for the near term is lacklustre. We believe that a period of consolidation is more likely than a period of correction (prices declining by more than 10%) because of the abundance of liquidity and a primary uptrend in earnings.

The medium-term trend is up

What feeds our confidence for the medium term is the breadth of the growth drivers: not only consumption is well oriented but capital expenditure, global trade and fiscal policies are too. This supports positive revenue growth and - thanks to operating leverage, share buybacks and strong base effects in commodity-related sectors and in financials - global earnings growth of 10% seems realistic for 2017, before some deceleration in 2018 as we get into a more mature stage of the economic cycle. Earnings releases in the first quarter have been extremely strong: +15% in the US and +29% in the euro area. The energy sector played a major role in this display of strength. Going forward, its contribution should become more limited but the breadth of positive contributors to earnings growth will be sizeable. Combined with further progression in earnings growth in 2018, this will provide the key underpinning to the positive trend that we expect to resume later in the year.

A period of consolidation lies ahead which should precede the resumption of a new uptrend later in the year.