Market Comment 12/11/2018
Grounds for Optimism
The Cornelian Investment team consider the opportunities presented by recent market falls and outline their grounds for optimism...
October saw significant equity market falls across all major geographic regions. Numerous suggestions have been put forward to account for the change in market psychology.
The most commonly cited reason for the sell-off is that the Chairman of the Federal Reserve said that current interest rates in the United States were a long way from neutral and that they may take interest rates above the neutral rate if they thought fit. This shouldn’t be a surprise as it is entirely in keeping with previous messaging released by the Federal Reserve (since March). Nonetheless, investors have become concerned that Federal Reserve action will instigate an earnings recession in 2020.
We take a different view and believe there are good grounds to be optimistic about the outlook for equity markets...
We take a different view and believe there are good grounds to be optimistic about the outlook for equity markets, notwithstanding the increase in volatility which is likely to persist.
First of all, at time of writing (09/11/18) other traditional indicators of risk (such as the yield spread between higher risk corporate debt and government debt, inter-bank lending rates and the relative performance of commodity stocks) are not suggesting trouble ahead.
Secondly, US economic data releases, in aggregate, are tracking slightly better than expected and, importantly, inflation expectations remain well anchored.
Thirdly, service sector confidence surveys across the globe continue to be robust.
Fourthly, despite the rhetoric, we expect a trade deal between China and the United States to be forthcoming. Such an outcome would be a materially positive catalyst to share prices.
Fifthly, the oil price had hit a new high at the start of the October and this triggered a reassessment of the impact of rising energy costs on some companies operating margins but since then the oil price has retrenched significantly.
Sixthly, US manufacturing companies are reporting that significant numbers of their customers believe that they are running with too little inventory following a period of stronger than expected demand. This suggests that customers will need to replenish stock levels and the positive impact of this on manufacturing company sales and margins is being under-estimated by investors.
...we expect a trade deal between China and the United States to be forthcoming. Such an outcome would be a materially positive catalyst to share prices.
We believe that the observed strong growth in capital expenditure by companies will persist and that this will drive productivity gains, earnings growth and help ensure that underlying inflation remains ‘well-behaved’. Banks in the United States (and elsewhere) continue to make it easier for corporates to borrow and this underpins our confidence concerning the persistence of the economic upswing.
The recent equity market falls leave valuations at attractive levels. The FTSE All-Share index is now trading on a forecast 2019 dividend yield of 4.6%. We view this pull back in equity markets as more of a buying opportunity than something more sinister.
Sources: Bloomberg, Bloomberg Indices, CitiGroup Global Markets Inc, Deutsche Bank, FTSE, Federal Reserve, IMF, ISM, Morningstar, MSCI, S&P
Cornelian Investment Team