Stock Market Outlook is Positive

The mood among global business executives is the brightest since 2014, with optimism about future growth and profits edging higher

Peter Gee 21 March, 2018 | 3:08PM
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The economic and financial news continues to show that the world economy is picking up pace.

The single most important statistic for the investment markets, the monthly employment announcement in the U.S., has been impressive. In February, there were 313,000 new jobs, way above forecasters’ advance estimates, the highest pick had been 230,000 and the average forecast had been 205,000. The unemployment rate has stayed at a low 4.1%, even though large numbers of people have decided to re-enter the stronger labour market, as there were enough jobs to absorb the new entrants.

Outside the U.S., the news has also been positive. The J.P. Morgan Global Manufacturing and Services PMI, which aggregates the national PMI indexes collated by IHS Markit, was strong in February: As J.P. Morgan commented, “The February PMI surveys signalled a further acceleration in the rate of expansion in global economic output. According to the PMI, growth hit a near three-and-a-half year high, as inflows of new business strengthened.

“The growth has been remarkably broad-based, with all sectors sharing in the expansion and with especially strong growth in telecoms services, the industrials sectors, and technology."

The OECD, in its just-released update to its Economic Outlook, is of the same view.

“Global GDP growth is estimated to have been 3.7% in 2017, the strongest outcome since 2011,” the OECD said, “with positive growth surprises in the euro area, China, Turkey and Brazil. Industrial production, investment and trade growth have rebounded, with global trade growth reaching an estimated 5.25% in 2017, and business and consumer confidence remain elevated.”

Market Outlook is Positive

The outlook is also encouraging. IHS Market polls firms every four months on the outlook for their businesses. The latest results, for February, found that “The mood among global business executives is the brightest since 2014, with optimism about future growth and profits edging higher again in February. Hiring and investment intentions are also at multi-year highs, as firms expand to meet anticipated sales growth in the year ahead.”

The OECD’s latest forecasts have also been revised upwards. It said that “The world economy will continue to strengthen over the next two years, with global GDP growth projected to reach almost 4% in both 2018 and 2019. Growth in the United States, Germany, France, Mexico, Turkey and South Africa is projected to be significantly more robust than previously anticipated, with smaller upward revisions in most other G20 economies.”

This is consequently a benign environment for corporate profits. With almost all the financial results now available for 2017 for the companies in the S&P 500, data company FactSet estimates that earnings per share in the December quarter were 14.8% higher than a year earlier, and even though the number was exaggerated by a doubling of profits in the energy sector, this year looks to do even better again.

On the analysts’ forecasts collated by FactSet, earnings per share are expected to rise by a strong 18.4%. Every sector other than utilities and real estate is expected to see double-digit growth in profits, led by the energy sector, financials, and raw materials.

Although the economic fundamentals have continued to improve, the outlook still faces some challenges. Despite the February sell-off, share valuations are still high, especially in the U.S.:

While they are not as pricey as they were going into the “tech wreck” of the early 2000s, U.S. equities are priced at 17.2 times expected earnings, a reasonably high level by historical standards. Shares are consequently vulnerable to any earnings disappointments – a real possibility given the lofty level of profit expectations – and to the impact of the progressive removal of global monetary support.

As the OECD commented, “The prolonged period of low interest rates and volatility has encouraged greater risk-taking, making the financial system more exposed to shifts in market sentiment as monetary policy normalises ... Further corrections in asset prices remain possible as monetary policy normalises, given the still-high valuations in some markets, including equity markets in the United States, housing markets in Canada and Australia, and corporate bonds.”

There is also the potential for unpleasant geopolitical surprises, particularly given the unpredictable outlook for U.S. economic and foreign policy. In recent weeks, the Trump administration has lost the head of the National Economic Council and the Secretary of State, and their replacements are likely to be more hard-line on issues such as tariff wars, a key risk to the global economic outlook, in the OECD’s view, and on confrontation with regimes such as North Korea.

It does not help that investors are putting little weight on the possibility of interruptions to the global business cycle. Although investors’ level of concern rose sharply in February, largely on fears of the valuation impacts of higher interest rates, more recently they have dropped back to less worried levels. While they have not fully returned to the over complacent levels seen in late 2017 and early 2018, they do not appear to be signalling any significant concern over shocks from left field.

The most likely scenario is that the progressively strengthening state of the world economy will underpin ambitious profit expectations, and equities will benefit. But it also seems likely that 2018 will spring more February-style volatility along the way as investors periodically reassess the state of the global business cycle and, in all likelihood, confront geopolitical surprises they are not fully prepared for.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Peter Gee  is a Fund Analyst for Morningstar Australia