Market Comment 18/04/2018
A positive outlook - after a rocky start
Hector Kilpatrick, Chief Investment Officer at Cornelian Asset Managers, assesses the current issues facing investment markets.
Market sentiment changed markedly during the first quarter of the year. At first, concerns that wage inflation in the US was coming through faster than expected and that this could force the Federal Reserve’s hand to increase interest rates by more than expected knocked confidence. This was followed by threats of a US/Chinese trade war which hit sentiment just as internet related business models came under the microscope.
Addressing these three issues in turn:
Whilst we do believe wage inflation is becoming an issue for some companies in the United States we also believe many companies in the US are planning to boost capital expenditure as the year progresses (see fig. 1). Automation of both manufacturing and service jobs is coming of age such that increased expenditure will have a marked productivity enhancing effect ensuring that economy wide inflation (and interest rates) remains well behaved.
On the potential trade war between the US and China, we believe that the Trump administration is using the threat of trade tariffs to get the attention of the Chinese authorities and it seems to be working. We believe that the current trade terms need rebalancing after years of negotiations and limited movement from China. The US administration has already spoken of some potential quick wins, whilst the Chinese have spoken about accelerating the opening up of their economy. There is, clearly, a deal to be done.
Internet related stocks have retrenched on the threat of the implementation of a global sales tax as well as well-founded questions concerning the monetization and use of personal data. Given the complexities involved, we believe it will be a long time before we see a globally accepted internet sales tax standard. The use of personal data by firms is a political hot potato just now, but we do not sense that consumers are over-exercised by it and so feel that whilst new regulations will be imposed on such companies, these companies will be able to adapt successfully.
We believe that companies in the United States will deliver earnings in line or better than those currently forecast.
The fall in equity markets has coincided with upgrades to earnings forecasts meaning that equities have become better value. We believe that companies in the United States will deliver earnings in line or better than those currently forecast and that in doing so, the final leg of the equity bull market could unfold, whereby core inflation remains well behaved and increased end demand results in strong profits growth.
However, given the risks to asset prices from the withdrawal of quantitative easing which will inevitably accompany the recovery, one should not be too ‘risk on’. However being too defensively positioned could also be expensive.
This constructive view is supported by an increasingly positive end demand picture that we are hearing about from company management teams that are exposed to the economic cycle. It is telling that many of the stocks that we use as positive indicators of how investors view the economic outlook have not led the market down and, indeed, a number of these stocks (such as the speciality chemicals producer, Croda (see fig. 2)) made new relative highs during the sell-off. We, therefore, remain constructive on equity risk and higher yielding corporate debt.
Cornelian Investment Team