Earnings expectations, policy, oil: The key troika of investor concerns
As we approach the end of 2014, there are three major issues that we believe are likely to need to be at least partially resolved before risk assets are able to make sustained progress. The first concerns earnings expectations and whether these are reasonable in an environment of slowing global growth. The second issue is in relation to policy, and in particular whether there is the political will to address the ongoing economic weakness in areas such as the eurozone. The third issue relates to the c.25% slump in the oil price since the summer and whether this is temporary or likely to be sustained.
Looking at corporate earnings, recent news from the US has been largely positive but the picture elsewhere is much less clear. The recent European earnings season has been unremarkable and a number of European companies continue to be affected by the slowdown in emerging markets. In Japan, stock market performance has been strong of late as companies benefit from a weaker yen and a stronger dollar but Abenomics seems to be losing some traction and Abe’s popularity has waned recently due to a number of political scandals. In China, economic growth continues to slow, with the economy on track for its worst annual performance since 1990.
The deteriorating global growth outlook, and the fact that there is relatively little that policy makers can do about it, is clearly a concern: monetary policy is spent with interest rates at or near zero in many of the world’s economies, and even countries that have been held out as examples of ‘sustainable capitalism’, such as Sweden, have had to cut interest rates to zero because of falling prices. Fiscal stimulus would normally offer some potential respite but the reality is that most governments already have far too much debt, so further spending to boost growth is not on the cards. On the monetary policy front, Japan’s move to expand its asset purchases is welcome, particularly as the Fed exits QE, although one of the economies likely to suffer most as a result of a weaker yen is Germany.
The major plus for risk assets is the boost to consumption and industry in the developed world that should arise from a weaker oil price. The flipside, of course, is greater fiscal pressure and currency volatility for oil-producing nations. Time will tell if the decline in oil is sustainable or just a phase, but falling energy prices (and hence weak inflation prints) should mean there will be little or no pressure for developed world central banks to contemplate raising interest rates until at least the second half of next year.
In terms of our asset allocation model, we continue to prefer equities over bonds but we want to see greater clarity on earnings and cheaper valuations before adding to our exposure, given the growth and policy uncertainties outlined above. Core government bond yields make very little sense to us at current levels but the current growth and inflation dynamics suggest that they could stay low for some time yet.
Mark Burgess is chief investment officer at Threadneedle Investments