Equity, investors' circumspection
21 March 2018
With all well at the start of the year, and 2018 carrying on where 2017 left off, we were expecting the equity markets to continue their progression accompanied by the synchronised global growth that was supporting activity and corporate earnings, with EPS up by some 10% more or less everywhere.
The equity markets continued to rise until 26 January, largely unscathed by the rises in interest rates and the EUR-USD exchange rate. That date marked a significant change in mood, with an equity market correction of around 10%. While European yields remained unchanged (1.01% for the 10Y OAT at end-February), comments by new Fed chair Jerome Powell prompted expectations of recurrent rate hikes in 2018 and a rise in US 10-year yields (10Y T-bond +0.15 bp in one month to 2.87%) focused the attention. The markets underlined this change in regime with a sudden spike in volatility, which was exacerbated by technical factors. The combination of the rise in interest rates and the return of volatility logically led to higher discount rates for future earnings, and therefore a correction.
The change in regime now seems to have been factored in by the markets, but despite a modest recovery since the end of the first week of February, investors continue to be wary. While we can say that the tensions on interest rates are still a factor, as well as concerns over a possible pick-up in inflation, it is also true that the leading economic growth indicators hit a ceiling a few days ago. However, these indicators have peaked at a high level, which is consistent with a global growth rate of more than 4% over the full year, and 2017 results releases are on a positive trend. When the markets closed on 1 March, 76% of Stoxx 600 firms and 97% of S&P 500 companies had announced their results. A majority of firms posted better-than-expected revenue and net income, on both sides of the Atlantic. In Europe, results improved after a lacklustre start to the season, with a level of positive surprises similar to that of Q4 2016. However, guidance from firms is below the targets indicated in previous quarters (30% below expectations vs 11% in Q2 2017 for example). In this climate of concern over inflationary tensions, and with results announcements coming thick and fast, rate-sensitive (long duration) sectors fell in February.
Investors are also considerably wary of rising political tensions, particularly with President Trump saying he will increase tariffs, which could weigh on global trade. We have previously raised this potential risk to trade agreements, and it has now become a reality. The measures announced should only concern steel and aluminium imports (with some exceptions), and could be in place from the end of March. On the other hand, President Trump’s comments, combined with the recent resignation of White House chief economic advisor Gary Cohn, suggest a possible tightening of the conditions for trading with the United States and, reading between the lines, a hardening of its stance over its trade, financial and competitive relationship with China. This resignation will weigh on the risk generating pressure on the equity markets and the US dollar, and therefore on the yen, and ultimately, on Asian equities.