LGIM’s Kreckel declares it is time to take equity profits
With global equities up since a June low point, Legal & General Investment Management global equity strategist Lars Kreckel declares it is time to take profits.
With hindsight there are reasons for the rally. The latest EU summit ended with more progress than expected, albeit against very low expectations. The Greek election at least delivered a functioning government rather than being the tipping point towards an exit from the euro. All major central banks announced further modest easing measures.
These improvements, combined with low expectations and bearish positioning were sufficient to trigger a short squeeze rally. However, when we take a step back from the day-to-day noise, it seems to us that precious little has really changed over the past few weeks, and what has changed has rarely been for the better.
Global growth momentum is slowing in all regions. The latest round of purchasing manager indices for June deteriorated further, with 80% of new order components (a good lead indicator) across the globe in decline. Even the US began to show signs of weakness with its PMI dropping below 50 for the first time since mid 2009. We are now getting to a point where another decline will likely trigger a re-assessment in growth expectations. Our economists expect indicators to stabilise at a low level rather than rebound in the second half of the year, but we believe equity markets are in a vulnerable position following the recent rally if this stabilisation does not materialise very soon.
One of the most hotly debated topics is whether policymakers will soon step in to support economies and markets with further unconventional easing measures (quantitative easing, credit easing, etc.). In our view such measures are not imminent. They are ultimately very likely, but further stress in the financial system and economy may be necessary to get central banks to make use of their limited options. Markets have rallied on the anticipation of policy changes, but subsequently sold off on disappointment over lack of detail, or the scale of intervention. ‘Bad news’ has turned into ‘good news’ because it makes it more likely Ben Bernanke will act sooner.
Consensus earnings forecasts are under increasing pressure. Earnings forecasts for 2012 have already been cut substantially across Europe, but the onset of the second quarter reporting season has accelerated the process further and cuts are beginning to spread to the US as well. Our own forecasts are substantially below consensus for 2013; where analysts expect a double-digit acceleration of profit growth, we expect low single-digit growth matching a sluggish economic backdrop. Earnings revisions are not always a great driver of short-term returns, but it is rare for equities to rally while cuts in forecasts accelerate.
In addition, we do not share the optimism about the EU summit. We do not deny that progress was made, but compared with what we regard as ultimately necessary it was a small step forward indeed. And if we have learnt anything from three years of eurozone crisis it is that the implementation of agreements is rarely smooth and that once market pressure eases, backtracking on plans is becoming more likely. Remaining sceptical over the effectiveness of policy changes has proven wise and we see no reason why this time should be any different. It seems government bond investors agree with this assessment, as Spanish spreads are back at pre-summit levels.