Markets remained under pressure over the month. The S&P/ASX 200 index fell over 1.5% in the past month as the potential of further escalation in trade protectionism and increased political tensions instigated risk-off sentiment. The US S&P 500 index fell by almost 5% before recovering in the last few weeks to be down about 1.5% for the month. Elsewhere, the European Stoxx 600 fared better as it was up about 1% over the month.
On the other hand, bond yields remain steady, with the US 10-year yield fluctuating around the 2.8% mark. Corporate spreads have widened however, following the sell-off in equities.
The Australian Dollar remains just under 78 US cents.
Trade rhetoric has improved in recent weeks as both US and China have indicated willingness to negotiate and provide concessions. However, Trump also tweeted accusing Russia and China of being currency manipulators just days after his own administration’s official report stated that it did not find any of its trading partners to be manipulating their respective currencies. This follows from increased political tensions with Russia following the attack on a former Russian spy in the UK and recent events in Syria, as well as the FBI stepping up its investigation into the meddling of the election by raiding the offices of Trump’s personal lawyer, Michael Cohen.
The employment market in Australia continues to be positive as February saw strong full-time employment growth. Retail sales also grew at a stronger than expected rate of 0.6% in February, after several months of disappointments. These readings bode well for the local economy, however, the tensions around trade have hit business confidence over the past couple of months and further tariffs or trade restrictions would have a negative effect on many economies.
During the month, US GDP for 2017 came in above estimates at 2.9%, and the US Federal Reserve boosted interest rates by 0.25% to 1.75% as widely expected. However, the Federal Reserve also boosted expectations of interest rates for 2019 and 2020, providing some upward pressure to longer-term yields. The US economy continues to be strong despite leading indicators coming in under expectations over the past month. Although lower than expected, the leading indicators still point to a continuation of strong growth.
Similarly, the leading indicator data in Europe were under expectations but indicate continued strength. Notably, inflation and unemployment continue to improve, providing some breathing room for the European Central Bank to start thinking about the end of its quantitative easing program.
Chinese data have indicated some slowing of their economy over the past month. Inflation readings and exports were below expectations by a decent margin, whilst first quarter GDP and March industrial production growth also missed. The People’s Bank of China responded by cutting its Reserve Requirement Ratio to 16% for large banks, which frees up liquidity in the Chinese economy, following numerous tightening actions over the past 18 months.
Looking ahead, the reporting season in the US has kicked off on a good note, but reactions have been mixed as some stocks fell despite beating earnings expectations. Earnings remains a strong driver for equity markets as valuations have fallen to long-term averages after the recent pull-back.
Earnings expectations receive a boost
Following the synchronised global growth environment last year which has continued into this year, companies have grown earnings rapidly. With tax cuts being passed at the turn of the year, earnings received yet another boost. As such, it is no surprise that earnings are expected to grow strongly this quarter and for the full 2018 year. The graph below shows how high earnings growth expectations are for this year.
As the graph above shows, earnings growth had already been strong in 2017 as companies rode the tailwinds of economic growth. The Trump tax cuts in the US add to earnings as a lower corporate tax rate means less tax expenses and a higher net profit. The extent of the benefit depends on the individual company’s tax situation, but it is expected to boost earnings by between 5-10% for 2018. The effect can be seen in the graph below, where earnings estimates spiked upwards in late December and early January as the market received confirmation and details around the US tax cuts.
While all of the above is positive for the US, what does this mean for investors in Australia?
Although the tax cuts and figures above are for the US market, there are many implications for investors in Australia. One is that Australian investors are more than likely exposed to the US in some form, either by holding international equities with direct US exposure, or holding companies listed in the Australian Stock Exchange that have US earnings and pay US tax. These investments should all benefit.
Australian investors would also benefit from the global synchronised growth, as seen in 2017. The earnings growth expectations in the US prior to the tax cuts were already high owing to the strength of the economy. As this is occurring on a global scale, Australian companies should also benefit, especially given the value of exports as a proportion of the economy.
However, it is important to note that the earnings growth expectations have been stable for the past few months, indicating that this is now well known in the market. Therefore, reporting season is likely to be the driving force of where the market goes in the near term. With the market having pulled back from expensive to a level closer to its long-term average (on a P/E basis), it is likely that a miss in earnings would lead to a fall in the market.
Conversely, a beat would likely be a catalyst for equities to re-rate upwards, and possibly the corporate spreads to narrow, providing a boost to investors of both. Thus far, the companies that have announced results early in this reporting season have generally beaten expectations. If this trend continues for this reporting season, investors should reap the benefits (provided there are no major political or other external shocks).
Another important aspect of reporting season is the commentary around future expectations from each reporting company. This could potentially cause a shift in earnings expectations for future quarters, much like the tax cuts did in the previous graph. Over December and January, US equities rallied strongly on the expected boost to earnings growth from tax cuts and all other markets followed suit. This shows the effect that a shift in earnings expectations could have on markets. Therefore, it is important to keep a watchful eye on not just the local reporting seasons of February or August in Australia, but also on the more frequent quarterly reporting season in the US as well as potential events that could cause a shift in earnings expectations.
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This month’s perspective highlights that market sentiment on all asset classes is constantly changing. It is important for us to quickly recognise any threats, to preserve your investment capital or to identify early investment opportunities to maximise any return advantages. At Partners Wealth Group we don’t get complacent with the current state of play and constantly monitor investments and your portfolios.
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This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider you financial situation and needs before making any decisions based on this information.