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Mounting macro risks stall rally

By: Alec Young, managing director, global markets research

Markets have grown more turbulent as investors come to grips with the Federal Reserve’s rate-hiking resolve in the face of a robust US economy and slackening growth elsewhere. Rising US rates, slowing Chinese growth and simmering trade tensions also loom on investors’ risk radar.

In its most recent analysis of global equity market conditions, our global markets research team provides an overview of the investment landscape and key macro risks.

Global growth enters the late stages

Consensus GDP estimates have converged on the view that global GDP growth is plateauing.

Leading economic indicators outside of the US continue to point to further weakening in global GDP growth in the coming year. Notably, a key gauge of China’s manufacturing activity fell to 50 in September, or just above levels signaling a contraction, while Eurozone sentiment readings were also lackluster, extending declines from peaks earlier this year.

What’s more, although the US economy remains the bastion of global growth, forecasters still expect it to slow in 2019 as tax-cut tailwinds recede and monetary tightening takes a toll.

 Market rate expectations in flux

The market’s interest-rate expectations (as implied by overnight indexed swap rates) have been persistently below the Fed’s dot plot projections, indicating pervasive doubts that the central bank will stick to its proposed tightening trajectory. Indeed, by our analysis, the recent spike in 10-year Treasury yields was mostly a reaction to robust underlying US economic growth (and expectations for further rate hikes) rather than higher inflation concerns.

Conditions today, however, warrant a closer look at the risks that could potentially upend the current consensus. For instance, US wage growth has now broken through recent resistance levels. A move above the 3% threshold could spark a sharp move by bond markets fearful that the Fed may fall behind the curve. This could provoke more hawkish Fed rhetoric and force market rates to rapidly close the gap with the Fed’s dot plot.

We may have reached a point where strong US economic news is perceived as bad news for financial markets.

 EPS growth fading fast

Consensus forecasts portray a global earnings cycle coming off the boil in 2019. Analysts foresee lower global EPS growth for most major regions next year, with the US (represented by the Russell 1000) and Asia Pacific ex Japan expected to see the sharpest declines and Europe ex UK and Japan seeing modest gains. It’s worth noting that this outlook would mark a significant narrowing in the currently outsized gap between US and other developed markets’ EPS growth.  

 Declines in three-month revisions to forward EPS have been especially steep for the Russell 2000, as tax-cut boost fades.

 

Valuations reset lower  

Forward PEs hit new lows for the FTSE World ex US, FTSE UK and FTSE Asia Pacific ex Japan following the October sell-off and came close to doing so for the FTSE Europe ex UK. Despite falling from roughly 17x at the end of September to just above 16x today, the Russell 1000’s premium to the rest of the world barely budged. The question for markets is whether this downward valuation reset now adequately reflects current global macroeconomic risks and a murkier profit outlook or whether it has more to run. Time will tell.

 

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