Valuation support for global equity in the face of slowing economic activity

In 2019, the fiscal stimulus in the United States (US) is likely to change from a tailwind to a headwind and the country is likely to re-couple with the global economy into a slowdown – but this should not panic investors.

The main theme in 2018 was above trend global growth with gradual economic deceleration and an upward interest rate trajectory. The US led the way, remaining decoupled from the global economy and this strength was reflected in a strong US dollar.

Global equity markets were expected to grind higher on the back of relatively strong earnings growth.

But as the year went on, there were increasing signs that economic deceleration was starting to pick up pace. In the US, the Republicans lost control of the House of Representatives to the Democrats suggesting that there would be no second phase to President Trumps fiscal stimulus. The US Federal Reserve (Fed) nevertheless maintained its rate hiking stance on a relatively upbeat assessment of the US economy and a tight labour market.

The combination of weakening growth, with obvious implications for earnings growth, and a rising cost of money via further rate hikes, started to unnerve risk markets with global equity markets pulling back meaningfully towards the latter stages of the year.

Does this mean that global equity markets will be lower at the end of 2019 compared to 2018?

We don’t think so. While we are talking economic deceleration, we are not contemplating recession. We anticipate downward revisions to earnings growth to come through as we move further into the year but that growth will still likely be positive.

Additionally, interest rate hike expectations have collapsed more recently and even the US Fed is sounding a lot more dovish. It is also entirely possible (and likely) that the Fed will slow its balance sheet reduction plans if economic data reflects further weakness.

This, together with relatively attractive global equity forward ratings (trading at below average 13X forward P/E multiples), suggest that equity performance will be positive in 2019 all things being equal. What are the warning signs we should be looking for?

An inverted yield curve with the long end of the bond curve below the short end typically suggests heightened recession risk (it has flattened considerably) so we will be watching this very carefully. Also, uncertainty around trade wars, Brexit and European politics will likely continue to dominate headlines for a while yet and need to be closely monitored.

ENDS