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29 April 2019

ECB: Next ECB President must keep up the pace of change.

Absence of a crisis risks a slowdown in pace of eurozone financial sector reform

Author: Alastair George

Alastair George is Edison’s chief investment strategist. He has extensive experience, having worked in global markets as a fund manager and risk arbitrageur since the 1990s. With an academic background in engineering and data science, he is well versed in the data-focused analysis of financial and political events.

In only a few weeks, European leaders will have to decide on a new ECB President to replace the incumbent Mario Draghi, whose term expires in October. Draghi has been a radical ECB president, deftly playing a difficult political hand to win support for a EUR 2.5trn ECB balance sheet expansion. In a time of crisis he offered “whatever it takes” to save the euro. We can now believe his claim that he would do enough to restore financial stability to the eurozone. Yet the ECB’s work in terms of monetary policy, regulation and eurozone financial integration is far from complete. Unlike Draghi, the incoming ECB President faces no immediate crisis. However, politically challenging further convergence of fiscal trajectories, economic growth and bank sector regulation is required to ensure the long-term viability of the eurozone project.  We believe markets would applaud an ECB President offering policy continuity in the short-term combined with the experience and political skills to ultimately drive further eurozone integration.

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8 March 2019

ECB: Buy the rumour, sell the news.

Markets had run ahead of ECB’s policymaking; valuations suggest near-term rally complete

Despite the ECB’s policy action yesterday, which pushed out the date of the first interest rate increase and confirmed a substantial package of targeted bank financing intended to ease credit conditions for the corporate sector, the market reaction was largely negative. Yet a key part of our bullish call in January was that equity valuations had retreated to levels which were close to long-term averages, a relatively unusual occurrence in this economic cycle. Since then, equity valuations have rebounded sharply as markets have risen while 2019 consensus profits estimates have fallen. This was largely in anticipation of easier monetary policy in our view. We now expect markets to trade only sideways in the absence of a near-term catalyst, while awaiting evidence of a turn in the economy during Q2/Q3. In respect of a US/China trade deal, the apparent cancellation of the Xi/Trump summit due in late March is however unhelpful for sentiment.

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22 February 2019

Global earnings: Pace of downgrades slowing.

Inflection point in downgrade cycle may have been early January

In a welcome development for global equity investors, the pace of 2019 earnings downgrades has eased markedly during the first three weeks of February. Furthermore, while 2019 consensus corporate profits growth has fallen from initial expectations of around 9-11% in developed markets to 6-8%, and from 12% in emerging markets to 10%, a profits recession now appears less likely.  It is still in our view a little early to have conviction this is the start of a sustainable trend. However, if it proves to be the case that earnings forecasts have stabilised it will be supportive of the rally in global equities.

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14 February 2019

Market outlook: balanced but still biased to upside.

Impact of lower rates, China tax cuts and political progress likely to be evident by mid-2019

Weak incoming data, both in respect of profits forecasts and the global economy is in sharp contrast to the strong performance of risk assets such as equities and corporate credit during 2019. Conflicting narratives can certainly create angst but in this case reflect investors’ belief that central banks have acknowledged the slowing global economy. We would concur that easier financial conditions means relief from negative economic surprises may be in sight by mid-year. Despite having risen sharply in the first few weeks of the year, on balance we believe global equities now have the prospect of volatile but still upward progress, as political events unfold.

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6 February 2019

Global earnings revisions still on a downward trend.

Equities bridging a gap in corporate performance - for now

Consensus profits forecasts on a global basis remain on a downward trend even as January’s recovery in risk assets such as equities and corporate debt continues into February. The primary reason for this at first sight paradoxical state of affairs is not hard to find; the US Fed has placed interest rates on pause and acknowledged the slowing of the global economy. Nevertheless, the clock is ticking on the persistence of the current profits downgrade cycle, which is also consistent with economic weakness evident outside the US. While not shifting our neutral stance on equities for the full year, near-term market performance is now in our view more tightly bound than usual to the turn in the direction of global profits forecasts. Therefore, in the short-term we would not chase the rally, at least until there is some evidence of stabilisation in earnings or positive news in respect of US/China trade.

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28 January 2019

ECB fiddles as eurozone turns.

Compared to US Fed, ECB seems flat-footed as growth slows

During the recent period of market volatility the US Fed has in our view successfully re-positioned itself on the doveish end of expectations, both in terms of interest rate and more recently balance sheet policy. The ECB in comparison appears flat-footed, with ECB President Draghi failing to use the opportunity in his press conference last week to emphasise policy flexibility in the event of a downturn. Ironically, the most recent disappointing incoming data is concentrated in the eurozone, rather than the US.

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10 January 2019

FOMC Minutes: Up to speed with events but US-centric.

Meeting minutes suggested Fed closer to market views than originally thought

The minutes of December’s FOMC interest rate meeting suggest the US Federal Reserve is in fact more attuned to the recent tightening of financial conditions and risk of a slowdown than first thought. Tweaks to the language in the FOMC’s December statement were intended to emphasise the data-dependency of the Fed’s monetary policy stance and also that only limited policy tightening was now envisaged. While we view this as reassuring for the remainder of 2019, the heightened volatility of global markets following Fed Chair Powell’s press conference demonstrates the ease of a miscommunication when interest rate policy becomes politically charged.

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19 December 2018

Brexit: Prepare for a confrontation.

No-deal preparations on both sides represent a predictable escalation in tensions

UK PM Theresa May has survived the confidence vote triggered by her own party. A further proposed House of Commons confidence vote is also destined to be defeated. However, PM May’s continued premiership does not mean there will be no change in Brexit tactics. She faces the same unresolved conflicts as before. In order to deliver her deal, she may shift towards a more confrontational position with the EU in order to obtain increased leverage. Investors should not confuse this with actively seeking a no-deal Brexit. However, the road to amending the Withdrawal Agreement and winning UK Parliamentary approval now seems paved with market volatility. While UK markets are now trading at valuation levels which discount a significant degree of Brexit disruption, declining earnings forecasts in both the eurozone and UK suggest that it is too early to materially increase equity exposure to these markets.

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23 November 2018

Economic survey data on a weakening trend outside US.

The fly in the ointment for investors trying to look through political developments

Following a difficult autumn, investors are likely to be weighing whether 2018’s risks are almost in the rear-view mirror. Brexit could conceivably be settled by January, with minor changes to the Withdrawal Agreement; the Italian budget stand-off could be resolved by a telephone call. In terms of financial conditions, the Fed may raise rates in December but could guide to a pause, reflecting economic or market turbulence. Similarly, the ECB could acknowledge that the weakening trend in eurozone data warrants a continuation of QE, or at least some very doveish forward guidance.  Finally, following the mid-term elections, rebel Trump’s politically motivated trade war on China is now without a cause, at least in the short-term. Speculation of a US/China trade “deal” at the upcoming G20 meeting in Argentina is rising, which could perhaps at least represent a cease-fire in hostilities. Such a shift in sentiment may seem far-fetched, but should at least be considered alongside more bearish scenarios.

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16 October 2018

Market valuations improving in UK and Europe.

There are risks, but valuation risk is slowly receding, with the exception of the US

October’s equity market volatility may already be in the rear-view mirror despite the evident risks of Brexit and lingering concerns over Italian debt sustainability. If markets stabilise close to current levels, the recent volatility may in hindsight be seen as a helpful correction towards aligning equity market prices to normalised interest rates and bond yields. Following the recent market declines, but following solid earnings growth and ROE in 2018 to date, median non-financial price/book levels, with the notable exception of the US, are now close to long-term averages. While there may be concerns over the sustainability of current profit margins, rising bond yields or geopolitical events, valuations can now move down from the top of investors’ lists of risks.

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11 October 2018

Rising US bond yields spark volatility breakout.

Synchronised declines in global equity markets may help stockpickers

October’s sharp declines in equity markets are being attributed to rising US bond yields. However, the surge in volatility is similar to that seen in January and raises questions about an underlying weakness in equity market depth rather than any radical change in fundamentals. It was hardly a secret that bond yields were likely to rise further over time given the strength of the US economy. Furthermore, a quarter-point increase in US 10y rates to 3.25% is not an especially large move. Recent increases in the US 2y rate perhaps went against the grain of Powell’s August comments but again were not especially noteworthy. We believe investors should first ensure that portfolios are appropriately positioned from a risk perspective, given the likelihood of a higher volatility trading environment.  Second, investors should be actively looking for securities which have been unfairly discounted in what has been an indiscriminate sell-off. However, we do not feel it is time to change our cautious stance on developed equity markets in general.

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17 September 2018

2018 Earnings forecasts stable over the summer.

Only marginal declines in EMs suggest that fears of an imminent crisis are overblown

There is a relatively strong correlation between the direction of earnings forecasts and the short-term relative performance of equity markets. Over the last 12m, US markets have outperformed peers as Trump’s corporate tax reductions and fiscal stimulus have provided a tailwind for US earnings. In the UK, although weighted earnings forecasts have risen, UK stocks have trailed behind, impacted in our view by the negative domestic sentiment in terms of Brexit. Similarly in continental Europe, market sentiment has been impacted by international and domestic political events. Intriguingly, the median emerging market forecast has only fallen by 2% since the Q1 peak, similar to the UK and Europe, suggesting fears of an imminent crisis are not at present feeding through to the corporate sector.

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12 September 2018

Choose your narrative with care for 2019.

Trade, politics or tighter US monetary policy? One may have a light at the end of the tunnel

In the 10 years since the global financial crisis of 2007-2008 there has been a perennial fear that the withdrawal of central bank support would lead to a collapse in asset values, which had been artificially inflated by ultra-low interest rates and asset purchases. With equity markets outside the US now having fallen by 13% in US dollar terms since the peak in Q1 18 as US interest rates have risen, it is very easy to become convinced this is the start of something bigger. While experience is in general an advantage, investors should beware of the risk of being too quick to make emotive links with the run-up to the 2008 financial crisis and emerging market crises of the 1990s. Notwithstanding the recent market declines, when we look ahead into 2019 we can see scenarios which imply a continued, albeit slower, global GDP and profits expansion - and a pause or slowing in Fed rate increases.

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23 July 2018

Earnings estimates: Marginal declines could point to trouble ahead.

Regions outside US now showing modest downgrades

Outside the US, most equity sectors have suffered modest downward revisions to 2018 earnings forecasts over the past four weeks. Within the US, 2018 earnings forecasts are effectively unchanged over the same period. It is too early in our view to be certain that this loss of momentum in non-US estimates is the start of a downtrend but it is consistent with the recent sharp declines in industrial commodities. The good news for 2018 – such as US tax cuts and continuing Eurozone expansion was always in our view a H1 phenomenon. The more challenging narratives such as rising US interest rates were in contrast likely to endure for longer. Furthermore, trade war uncertainty has reached a new peak.

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20 June 2018

Earnings revisions: No sign of a trade war (yet).

US estimates rising again while Europe and UK remain stable

In our view developed market equities remain in a benign de-rating phase, moving only sideways as profits rise and unconventional monetary policy is withdrawn. Critical to this view is a robust set of profits growth figures for 2018. Despite a significant slowing of economic momentum in the UK and Europe, consensus forecasts there still call for 8-9% 2018 earnings growth on a median basis. In the US, profits forecasts have seen another leg higher in recent months. The median US company is now expected to deliver close to 20% earnings growth in 2018. While there remain legitimate concerns and “headline risk” in respect of US trade policy, in our view and for the near-term, investors seem unlikely to dash for the exits with profits growth this strong.

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12 June 2018

Guaranteed security? Investment implications of US foreign policy.

North Korea summit opens the way to an easing of sanctions and international recognition – while G7 allies are left reeling

North Korea has recently made enormous progress towards re-integration with the world economy on its own terms, and in particular security guarantees for its incumbent administration. Development of nuclear missile capability in 2017, followed by the willingness to discuss the destruction of this same capability only a year later does indeed highlight that Kim Jong-un may be, in Trump’s words, a very worthy and smart negotiator. Potentially, the prize is as large as a return to the world community of nations. The contrast with the disarray at the meeting of the traditional G7 allies days earlier was striking - and these trade disagreements are the greater risk for markets in our view.

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7 June 2018

Global implications of rising US yields.

Tighter monetary policy and larger US fiscal deficits point to higher yields ahead – and a higher risk premium for emerging markets

Events in Italy may have highlighted a crowded short position in long-term bonds, with US 10y yields falling by 0.25% to 2.75% during a week of political uncertainty. However, US bond market investors still have to contend with rising short-term interest rates and a substantial increase in the issuance of US Treasuries to finance Trump’s tax reform. Furthermore, this is happening at the same time as the US Fed attempts to reduce the size of its balance sheet. Current 10y yields appear too low in the context of a continued economic expansion and emerging market policymakers are becoming concerned.

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25 May 2018

Energy drives estimates higher – but oil now under pressure.

Risks rising as Russia and OPEC debate turning the taps back on in H2

While it may seem that global investor sentiment has broadly improved over the last 3 months, following the rapid recovery in equity markets, returns have been dominated by the energy sector, Exhibit 1. With Russia and Saudi Arabia now discussing production increases to head off a loss in market share to US shale, this momentum in the oil price may now ease. Separately, despite volatility in emerging markets we note that profits forecasts have been largely stable in 2018, suggesting that any underperformance is due to the rising dollar rather than weakening profits trends. In developed markets, the median 2018 earnings estimate in the US continued to rise over the last month while in Europe and the UK estimates are stable, despite a marked slowdown in the economic data.

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25 May 2018

Italy: Political risk strikes (again) in eurozone.

Political power and resolve of EU and ECB should not be underestimated (again)

The prospect of a populist Five Star/League coalition government in Italy has spooked Italian bond markets with yields soaring in recent weeks. Nevertheless, this price move may still be viewed in the context of a correction, given the clearly large difference in fundamental credit quality between Italy and Germany, both from a political level and as measured by the government debt burden as a percent of GDP. It is a situation which is likely to create investor anxiety but the precedent of Greece suggests that the ultimate political power of the EU and ECB is considerable. An “Italexit” scenario would create a high degree of market uncertainty but remains low probability in our view.

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9 May 2018

2018 Earnings forecasts: Another Trump bump for energy.

Rising oil price continues to support 2018 earnings forecasts

While our concerns on valuation remain in place, in the short-term market performance is more closely linked to the trend in forecasts profits. Those looking for a reason to sell equities on this basis are likely to be disappointed. As we approach the half-year point, median earnings growth forecasts for the US remain robust at 18% while eurozone and UK equities are at 8%. For now, our base case remains that the benign derating – equities moving sideways while interest rates and profits increase - will continue.

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20 April 2018

High equity valuations face macro headwinds.

Factors behind record run of corporate profitability may be fading

We have had a cautious view on global equities for longer than has been comfortable. In truth, over the last 12 months this view has been 50% right at best. European markets, including the UK, have delivered relatively little capital growth. However the US and emerging markets have moved significantly higher. When the headlines are focussed on geopolitical events, it is also easy to lose sight of the anchor of equity valuations. We have updated our equity valuation measures and find that the US market in particular remains notably expensive while European markets still appear overvalued. We recognise that this has in part been justified by the record run of corporate profitability but the factors driving this phenomenon may now be going into reverse.

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16 April 2018

2018 Earnings forecasts: Still robust, for now.

Corporate sector soldiers on despite increasing geopolitical tensions

Geopolitics will in our view continue to present headline risk for the rest of the year. The US/China trade détente has broken apart as the US administration addresses the prospect of China challenging for dominance in the world economy. This weekend’s military response to the use of chemical weapons in both Salisbury, UK and Syria may for now be described as “mission accomplished” but it remains to be seen what the response would be to any further provocation. At the same time, there has been a run of disappointing economic data in the eurozone. Nevertheless, earnings estimates remain relatively stable for now in aggregate as the recent strength of the oil price leads to upgrades in energy, offset by modest downgrades in other sectors.

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23 March 2018

Market declines: US LIBOR or US trade war?.

Headlines scream trade war while a surge in US LIBOR is tightening US financial conditions

It is very easy to point the finger at US trade sanctions against China as a reason for the recent declines in equity markets. The prospect of a near-term confrontation, in respect of access to markets and IP protection (a free competition zone perhaps rather than a free trade area), is clearly unhelpful for global equity sentiment. China’s transition from a catch-up nation to an economic competitor always had to be resolved at some stage. However the second dynamic at work during Q1 18 is a rapid rise in US LIBOR, over and above that of official US interest rates. This is tightening monetary conditions rather faster than policymakers may have intended.

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15 March 2018

2018 Earnings forecasts: US stable, modest declines in Europe.

Watch for ebbing economic momentum as survey data peaks

Despite the increase in equity market volatility, there has been little follow-through to economic fundamentals to date. US earnings forecasts have stabilised and are indicating mid-teens profits growth for 2018, of which approximately one-half appears to be due to US tax reform. US economic surprise also remains relatively strong. In Europe however, unweighted earnings estimates have continued to fall, if modestly, and perhaps more importantly here economic surprise indices have turned sharply lower. We view this as partly due to Brexit uncertainty in the UK and a rising EUR exchange rate in continental Europe.

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6 February 2018

Volatility spike: Investors have only themselves to blame.

The only mystery is why markets were so placid in the first place

Perhaps controversially, we view the intellectual horsepower being consumed by the legions of writers commenting on every second’s movement in markets over the last few days not dissimilar to the wasted electricity consumed to validate speculative bitcoin transactions. Both activities are in our view of relatively modest economic value, even if there is currently heightened demand. There have been, in a historical context, only modest declines from the highs for major stock markets, albeit concentrated in the stronger local currency year to date performers of the US and Japan. In volatile times, investors must remain focused on the long-term outlook.

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1 February 2018

Rising bond yields: Mini-drama perhaps, but not a crisis.

Rising yields a ‘known’ risk – declining economic momentum would be a bigger concern

This week’s modest declines in equity markets may be the largest of the last nine months but that is only an illustration of just how far equity market volatility has fallen. The narrative of rising bond yields and inflation expectations is being used to explain the market declines. This is understandable and we ourselves have previously highlighted the anomalously low level of global bond yields. However, rising yields are a known risk for 2018 and unlikely to create a major sell-off in equity markets by themselves. We would be more concerned if there was firm evidence of a meaningful slowdown in economic momentum. Such evidence is - for now - largely absent in either Europe, the US or China.

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18 January 2018

Earnings: The real Trump bump.

Median per share earnings upgrade of 4% for S&P 500 following tax reform

Analysts’ profits forecasts have edged modestly higher in the first month of the year in continental Europe and the UK, as would be expected during a period of above-consensus global economic data. In the US however, tax reform has added to the cyclical economic strength, pushing median 2018 profits forecasts dramatically higher, up 4% over the past month alone. This represents 2/3rds of our total expected benefit to US earnings from tax reform. Earnings revisions data supports our strategic view of strong momentum carrying over into Q1/Q2 2018. However we also note that economic surprise indices may have peaked in January and combined with forecast rate increases, markets may yet tread water as the year progresses.

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14 December 2017

Market volatility unsustainably low as bonds and equities diverge.

Bonds and equities appear to be simultaneously pricing two scenarios – so why is volatility so low?

There is now a growing disconnect between low global government bond yields which appear to indicate that the global recovery of 2017 may prove transient and high equity market valuations which discount an extended period of strong profits growth. In addition, starting from Q1 17 there has been an astonishing and sustained decline in equity market volatility. While there is nothing which suggests a market regime change is imminent, we continue to believe that re-normalisation of monetary policy is likely to result in the re-normalisation of volatility, bond yields and equity valuations over the 2018-19 period. This is not in our view a good time to be seeking to maintain returns by increasing portfolio risk.

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4 December 2017

US tax reform a modest positive for US equities and dollar.

Estimated total corporate tax benefit of US$ 74bn per year is not a game-changer

The prospective headline cut to the US corporate tax rate from 35% to 20% is a positive but not as significant as it may look at first sight. Historically, the US corporate sector has enjoyed an effective tax rate closer to 25% due to ample scope for deductions. The US Congressional Budget Office believes that the total revenue lost from the US business taxes from the Senate tax bill would be $744bn over 10 years. Following implementation, this would represent approximately a 6% increase in net income for the US corporate sector from 2019.

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24 November 2017

Economic surprise accelerating.

Positive economic surprise still offering short-term support for risk assets

The positive economic surprise data seen over the last 3m continues to strengthen. If anything, the data is moving faster than any monetary tightening leading to a benign environment for risk assets such as equities. What is more of a conundrum is the lack of response in global bond yields, even as the final developed market central bank to move, the Bank of Japan, is now hinting that it is past peak monetary accommodation. Earnings forecasts for 2017 remain robust with median growth close to 10% for developed markets and a similar level of growth forecast for 2018.

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14 November 2017

Valuations: An important part of the puzzle.

Price/book multiples highlight worrying trend in risk appetite

In this cycle valuations have been, so far, the dog that did not bark. Globally, the median sector price/book multiple has risen from the trough of 2008 to a new peak. Such an expansion in market valuations is similar to that seen in the 1980-1987 period. Between 2012 and today we have come full circle in terms of tactical asset allocation. Earlier, we could not understand why investors were so uninterested in adding risk to portfolios despite such high expected returns in equities. Now, equity valuations suggest only modest long-term returns are on offer and there is greater prospect of short-term disappointment. It is however proving equally difficult to attract investors’ interest in this signal for caution. Perhaps the metaphorical - and silent - valuation dog knows the psychology of the current marginal investor rather too well.

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2 November 2017

Government bonds in the firing line.

The next twist in the story is likely to push global yields higher

It is always important to put aside preconceptions and let all the data speak – and not just that which confirms prior beliefs. At present, the data which best models the long-term outlook (valuations) are suggestive of relatively weak returns in global equities and this has informed our cautious positioning. Furthermore, bond yields and interest rates remain unusually low on a historical basis. Yet for the short-term, economic surprises are currently positive, business sentiment strong and profits growth relatively robust. It is this short-term data which also needs to be heard.

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19 October 2017

Profits forecasts stable – but no positive surprises.

Stronger PMI indices not following through to profits growth

While Q3 has brought something of a renaissance in economic surprise and purchasing managers’ indices we can at present see no sign of this improved sentiment in profits forecasts for 2017. Our weighted average consensus earnings forecast index remains steady for each of the UK, US and Europe ex-UK and the equal-weighted measures have declined, if modestly, since mid-year. In prior periods, our earnings forecast index tended to move slightly ahead of PMIs and economic surprise. The more recent data has not followed this pattern and highlights that what is good for the overall economy is not by necessity good for corporate profits. Furthermore, with central banks on a tightening path the risk for equity markets is that tighter policy is not offset by stronger profits growth.

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9 October 2017

Economic data surprising to the upside in Q3.

Strong PMI indices add weight to the case for tighter monetary policy

While valuation concerns for equity markets remain in place, recent economic data in the US and eurozone also points to something of a mini-surge in economic momentum over the last 3 months. PMI data has been coming in ahead of expectations and economic surprise indices have turned higher in all regions. During 2017, investors have had to balance their longer-term valuation concerns with generally robust profits growth and improving economic sentiment. While soft data such as PMI indices should not significantly shift portfolio asset allocations, a hiccup before the end of the year is now looking less likely.

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21 September 2017

US rates: Has the fuse been lit?.

Conditions for synchronised, if gradual, tightening of policy appear in place

To our surprise yesterday’s Fed statement and projections not only re-confirmed the probability of a rate increase later in the year but also continue to forecast three further rate increases in 2018. Furthermore, the Fed announced the pace of reduction in its balance sheet which, while an initially modest US$10bn per month in October will rise to US$50bn per month by the end of 2018.  The initial market reaction has been for the yield curve to flatten further as investors price in an increased probability of a Q4 rate rate increase while US 10y bond yields rose by only 3bps. Equity markets may be sanguine for now but we view this monetary headwind as a slow-burn fuse which may challenge investors again during 2018.

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16 August 2017

Earnings momentum remains stable for now.

Economic surprise driving EUR v USD but no FX hit to eurozone profits estimates

It may be the perfect environment for passive strategies as the lack of catalysts during 2017 has led to a continuation of the low volatility yet highly-valued equity market regime. In particular, it has been a robust year for corporate profitability. 2017 earnings growth forecasts remain pinned around 10%. Even while the medium-term outlook for markets looks challenging on valuation grounds as extraordinary monetary stimulus is unwound, those looking for a significant correction in the short-term should beware as corporate earnings trends remain robust at present.

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11 August 2017

North Korea: A problem not of Trump’s making.

Missile development program slowly shifts the political balance

North Korea’s recent successful test of a missile capable of reaching much of the US mainland is clearly a concern but it is not because such an attack is imminent or likely. The history of military rocket development suggests that it will still be some years before North Korea could be assured of a successful, let alone multiple, strike on the US or even Guam. However, in the event of any attack, the overwhelming superiority of US forces would undoubtedly ensure the destruction of North Korea. Therefore in many respects Trump’s most aggressive comments this week were a statement of the obvious and investors should accordingly not over-react, even as volatility has risen during thin trading over the holiday season.

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17 July 2017

Fed policy: Don’t forget your flip-flops.

US inflation and growth numbers undershoot expectations

It is just a few weeks since the US Fed raised interest rates and central bankers globally opined on a removal of monetary accommodation (albeit slowly) as the global recovery gathered momentum. Unfortunately, some inconvenient facts are already casting their shadow. The Atlanta Fed US GDP nowcast for Q2 17 has fallen to 2.4% from 4% at the start of June, with disappointing US retail sales contributing to the downgrade. Furthermore, core CPI has undershot expectations with the year-on-year figure now at 1.7% for June, compared to 2.3% at the start of the year. Fortunately for central banks, the holiday season has started and the focus may be elsewhere. However, some re-calibration of the trajectory of US monetary policy may already be necessary.

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29 June 2017

A tipping point as monetary policy shifts.

Central banks on both sides of the Atlantic appear to be becoming more hawkish

In recent weeks, policymakers at each of the US Federal Reserve, Bank of England and ECB have become notably more hawkish. This is a new development as throughout the period 2010-2017 central bank balance sheets have been steadily expanding as the quantitative easing (QE) baton was passed around the globe. With asset prices rising strongly over this period many commentators have been quick to infer that the end of QE signals market trouble ahead. While certainly a headwind, we believe investors should not rush to judgement. There remain many acts to play out in this story before it is finished.

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21 June 2017

Equity risks are rising: economic surprises turning lower.

Economic surprise turns lower and positive earnings momentum easing in Europe

We are viewing with increasing concern the building evidence of disinflation in industrial commodity and energy markets. Economic surprise indices have turned sharply lower on a global basis, a move which cannot be fully explained by seasonal factors. In this context we were surprised by the relatively hawkish recent policy statements by the US Federal Reserve and Bank of England. For the US Fed, it was very much a case of one and not done at the recent FOMC meeting, where US rates were increased again. For now, earnings growth forecasts near 10% for each of the US, UK and continental Europe remain intact but we also detect ebbing momentum in this data compared to 6m ago.

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12 June 2017

Fed rate decision: One and done - or not done?.

One and not done would spook markets in our view

On Wednesday 14 June, we believe the US Fed is highly likely to raise the target range for the federal funds rate by a further 0.25%. We believe the opportunity the move policy rates further away from the zero “lower bound” will not easily be passed-up as US unemployment figures improve and as importantly without spooking markets, which have priced this move in. However, a signal of “one and done” for 2017 – or at least “one and wait and see” will be critical to keep markets buoyant. In addition, investors will be watching for benign comments in respect of any adjustments to the Fed’s balance sheet policy.

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1 June 2017

Volatility: Low, but downside protection in demand.

We struggle to understand why market volatility has fallen so far in 2017

One of the notable aspects of equity market performance during 2017 has been the rapid fall in market volatility. Trailing 90-day realised volatility for the S&P 500 has reached 7% in recent weeks. Over the last 20 years, these are levels are matched only during a brief period over 2005-2006. We do not see an especially strong parallel with 2005 as at that point US equities were still moderately valued and the US economy was expanding after a mild recession. We believe investors are once again becoming complacent; but also note the skew towards higher priced put options suggesting within the options market at least that downside protection is at a premium.

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14 May 2017

Earnings forecasts: a short-term support for markets.

Rising estimates notable in continental Europe

While economic surprise indices may now be rolling over, US earnings forecasts for 2017 are effectively unchanged since January. In the UK and continental Europe forecasts have risen relatively sharply since the start of the year, reflecting in the UK a continued tailwind from sterling weakness and in continental Europe the long-awaited improvement in economic activity.

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5 May 2017

Not really an economic surprise….

Economic surprise indices and raw materials prices rolling over in Q2

One of the notable features of improving sentiment in global stock markets over the last 6 months has been its reliance on ‘soft’ economic data and a continuation of positive surprises. We cautioned in March that economic surprise indices were both seasonal and mean reverting and also highlighted the tightening of monetary conditions in China, historically linked to declines in iron ore prices. Six weeks later, global economic surprise has rolled over outside Europe while energy, coking coal and iron ore prices are falling sharply.

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24 April 2017

French Election: Is populism already passé?.

Relief rally follows 1st round vote which puts Le Pen against a moderate

If last year was the year investors were caught out by misleading polls, today’s market action suggests that investors are being caught out by mistrusting them. A collapse in near-term euro volatility, sharply higher equity markets and a compression in the spread between French and German government bonds emphasises the relief that Le Pen was not in a run-off with a far left-wing candidate.

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23 March 2017

Market wobble? Still time to re-position portfolios.

No clear trigger for recent market declines

Even if some calm has now returned, the market declines this week are perhaps a little more disconcerting than usual as they have occurred with no obvious trigger and followed an extended period of very low volatility. This makes the situation a little more uncertain, as specific triggers can often be analysed, quantified and discounted. There is therefore the danger of investors becoming fearful of the unknown - and risk averse - should the declines become more serious.

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16 March 2017

Just what the Fed wanted.

A rate increase and a rising market – but was it really dovish?

Having primed markets to fully expect a US rate increase, the FOMC followed through on the 15th March. If the aim was to deliver a rate increase without abruptly causing tighter financial conditions (code for declining equity and credit markets), then it was mission accomplished. Following the FOMC announcement the dollar eased against other currencies, bond yields fell and equity markets gained. However, despite comforting language within the statement we detected a more strategic, rather than data dependent, direction for US interest rates in the press conference Q&A.

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13 March 2017

Ready for the rollover?.

Tentative evidence of slowing economic momentum

Despite buoyant global asset markets, we are seeing increasing evidence of slowing economic momentum. In the US, bank loan growth has slowed significantly since Q4 16 and the Atlanta Fed’s GDP nowcast is only indicating 1.2% US growth for the current quarter, compared to over 2.5% as recently as early February. In the UK, the services PMI peaked in January and is now declining while in Europe - a bright spot in terms of economic surprise – disappointing German factory orders cast some doubt on the durability of any recovery. China’s M2 money supply growth has also ebbed since Q1 16, suggesting an easing of basic materials prices, should prior correlations still hold.

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23 February 2017

FOMC minutes: Fairly soon = March or June?.

FOMC minutes highlight risk market will be caught offside by Fed in 2017

The most recent FOMC minutes suggest to us that March is a live meeting for the next US interest increase, in contrast to market expectations which imply a less than 20% probability of a hike. We believe the market continues to underestimate the resolve of the US Federal Reserve to use the opportunity of low unemployment and close to target inflation to re-normalize US interest rates.

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16 February 2017

C’est l’économie… French and German bond yields diverge.

It’s not the unlikely election of Le Pen, it’s the economy ...

The recent divergence between French and German government bond yields has been widely attributed to a possible victory for the anti-euro Marine Le Pen in the French presidential election. In our view this is not the whole story. The widening gap in terms of borrowing costs also mirrors the increasing economic divergence between France and Germany. Therefore, the increased risk premium for French government debt should be expected to persist, even after the election of a mainstream candidate, adding to pressure on the euro project.

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16 January 2017

Earnings Revisions: Waiting for upgrades?.

Though global equities continue to benefit from significantly increased investor optimism, US and continental European earnings forecasts for 2017 have remained stubbornly static over the last 3 months. However, in the UK 2017 earnings estimates continue to move higher, tracking the decline in sterling and providing a degree of fundamental support for the FTSE100. For US and continental European equity markets, the increasing divergence between 2017 profits forecasts and their respective price performance, when added to the lack of valuation support, puts a question mark over how much further the rally can run.

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9 January 2017

Valuations trump noisy narratives: increased caution on global equities.

Price/book valuations point to sub-par equity returns over the next 12m

Judging only by current equity market valuations, global equity investors are significantly more likely than usual to achieve only below average returns over the next 12 months, if prior correlations remain a guide to the future. Average price/book multiples for world equities are once again at peak levels, similar to those prevailing in 2007 and 2000, and this is reinforced by a similar picture for P/E ratios. We believe investors should factor in the possibility that broad equity market exposure may result in weak or negative returns and stock-pickers cannot rely on a tailwind of benign markets over the next 12m.

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5 December 2016

You can’t be given a bloody nose twice.

The vote ‘no’ to Italian constitutional reform in this Sunday’s referendum has cost the Italian prime minister Renzi his job and perhaps thrown the Italian government into turmoil. Markets are however not in turmoil. The euro is close to unchanged, having fallen modestly after the referendum result. European equity markets are sharply higher this morning. While Italian 10y government bond yields have breached 2%, this increase in yields is notably less sharp than at the time of Trump’s election. Investors who panic sold after Trump and Brexit have been reconditioned (correctly in our view) to not immediately re-price risk on the back of specific political events.

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14 November 2016

Forward guidance - Trump style.

These are strange times in global markets. Trump’s election, previously feared as a universal negative for global markets, has been accompanied by remarkable strength in risk assets. We highlighted investor positioning as a factor last week but now question if there is there more to this rally? Could Trump’s fiscal policies represent a “whatever it takes” moment?

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10 November 2016

Trump’s double surprise.

It is quite clear that in the days leading up to the U.S. Presidential election, both markets and surveys got it wrong. Traditional polling once again failed to spot the depth of support for radical political change. This was after all the U.S., which has delivered the strongest post-crisis economic performance of any developed nation. 

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4 November 2016

BOE: Bank on track.

Today’s BOE decision represents a correction in UK policy makers’ thinking. The sudden stop in activity which was implied by the Bank’s August stimulus package has not materialised and the focus has instead returned to significantly above-target inflation by 2018. This is going to be supportive of sterling, especially as consensus views on the exchange rate had become so negative.

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21 September 2016

Just don’t mention the yen.

Today’s “Comprehensive Assessment” by the Bank of Japan of its stimulus efforts has in our view underemphasised the role of the weaker yen in bringing Japan out of deflation. The data show a very strong link between lagged moves in USD/JPY and Japan’s core inflation rate, Exhibit 1. Moves in the yen over the last year indicate that Japan’s core CPI may once again be falling back towards zero which may induce the BOJ to engage in further stimulus efforts. However, we wonder if the lower bound on interest rates is not the only constraint central banks are now facing.

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1 September 2016

UK economy and corporate profits: Refusing to follow forecasts.

Since July, there have been over 250 UK corporate earnings reports or trading statements, which we have been tracking for any sign of Brexit-related weakness. Within these corporate filings we can find little evidence, in either outlook statements or in managements’ referendum commentary, to suggest a slowdown in trading is underway.

On the contrary, over 80% of company earnings reports indicate that trading is in-line with earlier expectations. Furthermore, 16% of companies report that trading is ahead of expectations against only 3% reporting that trading has fallen below expectations. In addition, recent data on house prices and manufacturing surveys seem to confirm that fears of a Brexit-induced slowdown in the UK have proved overblown, over the summer at least.

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16 August 2016

Earnings forecasts: Reassuringly stable?.

Recent trends in consensus earnings forecasts highlight analysts’ confidence in corporate performance for 2016, even as GDP forecasts continue to decline. For now, it appears that the global phenomenon of steadily declining earnings forecasts, a factor behind the relatively weak 2015 equity market performance, has ebbed. There also remains no observable impact on aggregate UK earnings forecasts from Brexit to date, although as we have previously noted for the UK, FX benefits for exporters have offset modest downgrades to sectors focused on the domestic economy.

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10 August 2016

Gilt shortage: It takes two to tango.

Yesterday’s failure by the Bank of England fully cover its bond purchase order indicates that the re-introduction of QE has created a significant squeeze in the UK’s bond market.  This auction failure highlights a possible constraint on the BOE’s QE policy, at least until a more expansive fiscal policy delivers a significant increase in the future supply of gilts or substitute securities.

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RSS - Strategic Insight
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*Multiple Sectors
28/11/2019
Equity strategy and market outlook - November 2019

In this month’s strategy piece, Alastair believes that the impact of the easing of monetary policy during 2019 is still only likely to start to feed into the real economy by early 2020. The prospect of an improvement in economic conditions is now driving a substantial positive shift in investor expectations, leading to a reduction in risk premia and higher asset prices across asset classes. The US/China trade conflict appears to be moving towards a Phase 1 trade deal and at the time of writing the UK’s Conservative Party is sufficiently ahead in polling that in 2020 both a resolution to Brexit and a re-centring of British politics are now reasonable prospects, in our view. Nevertheless, based on the rally in global markets during the autumn, we believe a significant proportion of this political good news is in the price. Long term, the cohort of the largest global equities appears priced to offer returns in excess of currently very low yields on government bonds. We remain neutral on the outlook for equities, with the near-term risks of a relapse in confidence given the recent rally balanced against the more positive longer-term view. Finally, government bond yields appear at risk of further increases should the incoming economic data continue to improve.

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