By Philip Lawlor, managing director, head of global markets research
The pickup in headline first-quarter US GDP growth sent out false signals about the underlying health of the US economy, as a closer analysis reveals. And the recent flare-up in US-China trade tensions isn’t helping.
As we highlight in our latest overview of the global equity markets, even the pacesetting US economy has been losing momentum for the past several quarters. The US Q1 GDP benefited from mostly transitory gains in net exports and inventories. Personal consumption growth and final sales to domestic purchasers (a measure of household and business spending that excludes exports and inventories) have slowed sequentially since Q2 2018, as has nominal GDP (see chart below). A protracted US-China trade war and new tariffs, if sustained, would impose additional strains on US consumers and businesses.
Trade conflict reignites global growth fears
Market sentiment remains fragile. With the recent escalation in the US-China trade war, overnight indexed swap markets are pricing in greater odds of at least one Federal Reserve rate cut this year. In past cycles, Fed rate cuts have coincided with signs of weakening US wage growth, a lagging indicator. It would appear, then, that the market believes that US pay gains have already peaked. This also suggests if wage growth continues to accelerate it might prevent the Federal Reserve from delivering the rate cuts the markets expect.
The upswing in safe-haven currencies since March, the recent inversion of the US Treasury yield curve (with three-month bill yields rising above 10-year bond yields for the first time this policy cycle) and the sharp falloff in safe-haven sovereign bond yields (see chart below) lend further credence to rate-cut expectations.
The good news − US EPS forecasts improve
The stronger-than-expected Q1 GDP and earnings results have driven a decisively positive turn in consensus 12-month-forward EPS forecasts for the Russell 1000® and 2000® Indexes, following several months of steady declines (see chart below). For most other developed markets, the downtrend in forward EPS estimates appears to have bottomed, with the exception of Asia Pacific, which has continued to see downgrades.
While consensus analyst forecasts have been cut significantly over the past six months, the Russell 2000 remains the earnings growth leader, with 2019 EPS now projected to advance 14% year-over-year. That compares with expected gains of 3.5% for the Russell 1000 and of 4.1% for the FTSE World ex US Index.
The good news − global selloff clips valuations
The recent retreat in global equities brought valuations mostly lower across most developed markets. At 16.9x consensus 12-month-forward EPS estimates, the FTSE US multiple remains well below its 2018 peak and three-year average.
On this basis, the FTSE US also retains a sizable 36% premium relative to its global peers. Moreover, viewed through the lens of long-term inflation-adjusted price/earnings ratios (the moving-average PE, or MAPE), the FTSE US Index represents the only market with a current reading above its 20-year average and stands at almost twice the levels of FTSE Europe ex UK and FTSE Asia ex Japan Indexes.
It is important to assess the equity outlook within the context of this evolving macroeconomic environment. Given the lessons of past late-cycle eras, incoming data suggest continued crosswinds for risk assets.
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