Global economic growth remains on track. The IMF has once again revised its expectations for 2018 upwardly, thanks mainly to strong growth in emerging markets. The slight decline in the global PMI manufacturing is the result of country-specific issues such as the turmoil in Turkey and strikes in Korea.
In the US, pressure is somewhat increasing, with growth having slowed down during the first quarter. Activity surveys remain nevertheless solid. Consumption growth should remain dynamic. Despite moderate hourly earnings growth, total wages are growing at a 5% year-on-year pace. Meanwhile, investments remain firm and exports are supported by dynamic world activity. GDP growth should be close to 3% this year and the Fed is expected to continue to pursue its monetary policy normalization.
In the eurozone, the recent decline in the economic activity indicators is no reason to be anxious, as it is just a normalisation in line with real economic growth. GDP should reach 2.5% this year, supported by exports benefiting from high consumer confidence, employment and income growth, exports benefiting from strong emerging market growth, and firm investments.
We thus still validate the Goldilocks scenario, though there are some downside risks to our core scenario, such as the oil price increase and trade tensions between the US and China.
Over the past few months, global growth has been less synchronised than last year. PMIs (manufacturing) remain, globally, firmly above 50, but momentum has slowed down. We are nevertheless witnessing a narrowing growth momentum between the US and the eurozone, as economic surprises are starting to rebound for the latter. This, in combination with a EUR/USD that has stopped rallying, has brought the recent underperformance of EMU equities versus the US to an end.
The Fed continues to gradually tighten its monetary policy, as conditions in terms of growth, inflation and labour market are being met. Tolerance for an inflation level overshooting 2% is nevertheless putting the Fed to the test.
In the eurozone, the situation is different, as the ECB is in no hurry to tighten, given the low inflation figures. We believe the central bank is likely to wait for the summer before shifting rhetoric.
Earnings – Expected returns
The first-quarter earnings season was supportive of equities. In the US, around 80% of companies in the S&P 500 having already published beat earnings expectations, for a year-on-year estimated growth of 23%. Most sectors printed double-digit earnings growth. For the coming twelve months, we expect US earnings to grow 14% nominal, as the fiscal easing of the Trump administration is now fully integrated into earnings-growth expectations. In Europe, 60% of the companies in the Stoxx Europe 600 beat earnings expectations, delivering 15% year-on-year growth. Results are 4% above initial consensus expectations. Earnings should grow 8% in the coming twelve months.
Tensions eased last month. Investors are now less optimistic regarding equity markets for this second quarter 2018 and still recognise a potential trade war as the biggest “tail risk”. Also, the short USD is becoming one of their concerns, as most crowded trade, according to the BofAML Fund Manager Survey.
Although the noose is tightening between equities and bonds, we still think that equity markets are more attractive. First of all, our core scenario remains supportive, with positive economic growth, strong earnings growth and attractive relative valuations. Downside risks nevertheless remain, justifying our neutral stance in equities. We are closely following the news surrounding the trade tensions between the US and China, the possible impact of a macro peak and a possible acceleration in monetary policy normalisation in the US.
The US – where the political risk premium seems to have declined – is still navigating full speed ahead. The country is being carried along on Trump’s fiscal policy, including a 100bn USD share buyback for Apple alone, a strong earnings season in Q1 and a gradually tightening Federal Reserve Bank, as conditions – in terms of growth, inflation, and labour market – are met. As a result, the USD has strengthened and the 10-year Treasury yield has touched 3%. Hence, even if Trump’s fiscal easing has now been integrated into earnings growth, valuations, at the same time, should be impacted by an increase in rates and lower expectations for 2019-2020, which explains our remaining neutral on US equities.
Fundamentals remain supportive of the EMU markets and valuations now seem to be slightly up again, reaching a record high (14.5%) in a context of interest-rate increases. Furthermore the EUR non-appreciation is having a positive impact on European corporate profits. We now await any relevant trigger to reinforce our convictions, justifying the maintenance of our neutral stance.
Europe ex-EMU equities
Brexit negotiations increased the risk premium and domestic fundamentals are weakening. Ex-EMU markets, which have the lowest expected returns, are driven by a negative multiple expansion that has convinced us to stay negative in this region.
Valuations are starting to become attractive, leading us to remain constructive beyond 2018 and 2019. We confirm that above-expansion growth in Japan is still relevant and the recent yen depreciation should now support Japanese equities. However, the region retains lower earnings growth expectations, justifying our neutral stance for the time being.
Emerging market equities
USD strengthening has negatively impacted emerging markets. Still, they benefit from strong global growth, and valuations are, as we expected, estimated at 12%.
Negative on government bonds and corporates
Financial conditions are tightening in the US as the Fed progressed in its rate-hike cycle. We are targeting around 3% for the 10-year Treasury yield. We expect that inflation should increase gradually and that the momentum of global expansion will continue. But, as the carry remains lower than expected, we still maintain a negative stance.
Neutral on high yield
High-yield spreads are close to our targets and some pressures are starting to appear, as these spreads have failed to offset the rise in government bond yields. Furthermore, carry is low in the eurozone and, although decent in the US, penalized by the absence of hedge cost.
Positive on emerging debt and inflation-linked
Emerging debt and inflation-linked are the asset classes that remain attractive. Emerging debt is still benefiting from an attractive carry and inflation-linked bonds are advantaged by the context of the inflation rise.