By Philip Lawlor, managing director, head of global markets research
Equity markets have been rallying on the decisively dovish turn in Federal Reserve and European Central Bank positioning and optimism about the macro rewards such stimulus may bring. But, as highlighted in our latest overview of current macro conditions, we note a persistent mismatch between market expectations and incoming economic signals.
A challenging growth backdrop
Leading indicators and consensus forecasts suggest little to no improvement across the major economies next year. Current projections call for a sharp year-over-year slowdown in US GDP growth in 2020, putting it barely above the flat to marginally higher gains projected for the UK and the Eurozone.
Policymakers (and bond markets) are increasingly alert to the continued erosion in incoming economic data. The chart below shows the ongoing weakening in the Eurozone Economic Sentiment Indicator and the “economically weighted” US Institute for Supply Management (ISM) survey. The US survey blends the US manufacturing and services/non-manufacturing results through June and is weighted more to the latter sector, which accounts for nearly 85% of US output.
Although readings for both regions still signal expansion, they have fallen steeply over the past year. These surveys reinforce the latest composite leading indicators from the Organization for Economic Cooperation and Development (OECD), which also signalled further slowing growth across the major economies six months out.
Lackluster growth prospects are also suppressing market inflation expectations. The chart below plots the 5-year/5-year forward inflation expectation rates for the US and the Eurozone, the preferred and closely watched metric used by both Fed and the European Central Bank policymakers. Though this gauge briefly spiked upward for both regions following the accommodative messaging from their respective central banks in late June, they have resumed their downtrend since then.
Can the Fed fully meet market expectations?
The Federal Reserve and European Central Bank (ECB) have both made clear their willingness to adopt more simulative monetary policies. Fed Chairman Jerome Powell has all but promised to cut rates this month. But a bigger question is what happens next? Futures markets have priced in a 100bps cut in the Fed funds rate through 2020, starting this July, a far more aggressive trajectory than the Fed’s latest ‘dot plot’ is signalling (see chart below). This increases the scope of disappointment if central banks fail to meet the pace and magnitude of easing markets expect.
How much confidence should be applied to 2020 EPS forecasts?
Consensus 2020 EPS forecasts anticipate a robust recovery in growth off this year’s depressed levels (see chart below). EPS growth is expected to nearly quadruple year over year for the Russell 1000 in 2020 and to double for the Russell 2000. Asia Pacific leads this global earnings resurgence, with EPS projected to gain nearly 12% next year, a considerable turnaround from the steep decline forecast for this year.
However, analysts’ forecasts tend to be optimistically biased and to get trimmed as the year evolves, as has been the case this year. Consensus EPS estimates for this year have fallen more sharply than those for 2020, widening the ‘rebound’ gap between the two.
The combination of slower economic growth and declining inflation creates a headwind for revenue growth, posing a threat to operating leverage and the EPS growth outlook. As time elapses, the risk is that investors ultimately come to see the glass is half empty, not half full.
© 2019 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”) and (7) The Yield Book Inc (“YB”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®”, “The Yield Book®” and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under license, by FTSE, Russell, MTSNext, FTSE Canada, Mergent, FTSE FI, YB. FTSE International Limited is authorized and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided "as is" without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of FTSE Russell indexes or research or the fitness or suitability of the FTSE Russell indexes or research for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell indexes or research is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analyzing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this blog or links to this blog or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice, and nothing contained in this blog or accessible through FTSE Russell indexes or research, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a license from FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB, and/or their respective licensors.