Earnings season has come around again and will be a key driver over the next few weeks as the market has been pretty flat over the past four weeks, though there was some volatility in between as the U.S. and China met to discuss trade. The S&P/ASX 200 was up 0.5% but fell below 6,500 at the start of October before some positive headlines and comments post the trade meeting sparked a rally back above 6,700. The S&P 500 was down 0.5% over the same period, though it did fall nearly 4% in between. Europe and Japan continued to be the outperformers as the Euro Stoxx 50 and Nikkei 225 were up around 2.2%. Meanwhile, China’s CSI 300 index posted a 1% gain.
Commodities fell as growth concerns came back to the fore causing industrial metals to sell off. Oil fell over 12% and is now below the levels before last month’s spike caused by the attack on Saudi Arabian facilities. Gold also fell over the past four weeks as the big year to date rally showed some weakness. Meanwhile, agricultural commodities rose as China may restart large purchases as part of a trade deal.
Bond volatility continued as U.S. and Asian yields fell, but European yields rose. Overall, the Bloomberg Barclays Global Aggregate was little changed.
The Australian Dollar continues to trade around 68 U.S. cents.
Trade dominated headlines again as the U.S. met with China, resulting in ‘phase one’ of the trade deal being announced. It is nothing new; China will buy U.S. agricultural products in exchange for a freeze in tariff hikes. Sound familiar? In reality, the primary issues of intellectual property and technology have yet to be sorted and even ‘phase one’ has not been signed yet.
Economic data globally remains weak. Australian consumer and business confidence are worsening, though employment remains resilient with the unemployment rate dropping to 5.2%. However, this may not continue as job advertisements continue to fall. In the face of increased risks to the economy from the global slowdown, the Reserve Bank of Australia (RBA) cut rates once again to 0.75%.
The U.S. does not look so great either. After showing strong resilience to global ails, the U.S. consumer looks to be weakening over the past months, with activity indicators below expectations and employment growth slowing despite the unemployment rate falling to 3.5% as participation fell. Retail sales and consumer confidence have also been falling. These are significant concerns given the consumer accounts for nearly 70% of the U.S. economy.
Europe remains weak as Germany continues to flirt with recession and manufacturing and exports continue to fall. Calls for fiscal stimulus continue to get louder, but quick action on this end is unlikely.
Like the U.S., China’s service sector has also shown signs of slowing, and trade continues to falter as exports and imports fell more than expected in September. There is a ray of light through the shadows though, as China’s manufacturing indicators came in better than expected and are showing some signs of a potential rebound.
Moving forward, the quarterly earnings season is upon us. Locally, the banks will be reporting, and many other companies will be holding their Annual General Meetings during this period. Expectations are low and early reports have been quite positive, so we may see a rally in the short term, but unless global economic growth turns around, future earnings will be at risk.
Australian equities near record multiples
The S&P/ASX 200 has outperformed many other markets, including the U.S. S&P 500 and MSCI World indices since the start of 2019. At the same time, the weighted average earnings of the Australian index have fallen more than many other markets as per the chart below. This has left valuations near the highest ever recorded for the S&P/ASX 200, at least on a headline one-year forward Price over Earnings (P/E) multiple. This makes current valuations look expensive relative to its history. At 16.9x P/E, the local index is more expensive than the U.S. and the world, meaning that it is also expensive relative to other indices, especially given that most other indices are trading close to their average valuations.
Indeed, the index is more than one standard deviation above its historical P/E multiple, which makes it look very expensive. However, this does not mean investors should run for the hills as there are other things to consider. For one, Price to book (P/B) is barely above the historical average, while the S&P/ASX 200’s valuation relative to bonds indicate that the equity market is extremely cheap.
The other thing to note is that P/E is not just affected by price, but by earnings as well. The forecasted earnings have continued to be negatively revised since the start of the year, but there have been three rate cuts by the RBA to 0.75%, new tax relief measures and a bottoming in house prices over the past few months. This should provide some food for optimism that the domestic economy will improve, and forecasted earnings will be revised upwards.
Further to this, there are pockets of opportunities within the market itself, where some sectors are trading extremely cheap relative to their historical averages and the broader market, though there are sectors that are trading extremely expensive.
All of this means that there are still opportunities for investors to profit and should remain invested. However, such an environment may favour active investors with the ability to invest selectively in undervalued spaces.
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