Summer rally likely to continue says LGT’s Kumada
After retreating to a temporary lull in April, the bulls have returned to global equity markets in full force argues Mikio Kumada, global strategist at LGT Capital Management.
The economic data flow has improved and interest rates, along with inflation expectations, have been edging higher as well. Meanwhile, the next earnings season is not too far away either, and with profit forecasts still within reasonable bounds even after a five-year bull run, there is little reason to worry too much about the ongoing summer rally ending prematurely.
It looks as if “sell in May, go away” didn’t work this year. The Euro Stoxx has risen by about 2% since 30 April, the S&P 500 added 3.5%, and even emerging markets and Asia, which have been comparatively weak for some time, performed well. The MSCI Asia Pacific ex-Japan rose 3%, while the MSCI Emerging Markets climbed 5.3%. But the biggest gainer is the market that looked rather tired for most of the first half of the year: Japan’s Nikkei 225 surged 7.5%, which is all the more remarkable because the yen was actually relatively stable during the relevant period. In short, the summer rally has reaffirmed that the global bull market is alive and well. It also confirmed that the recent years’ relative performance patterns haven’t changed either.
Of course, we cannot exclude the possibility that the above mentioned market adage could still come back to haunt us at some point this summer. For now, however, that doesn’t look likely. It would require a truly shocking international event to break the markets’ underlying strength. After all, we have just been confronted with a series of alarming events and their potential implications, including the Ukraine crisis, anti-Chinese riots in Vietnam, a military coup in Thailand, close encounters of the potentially violent kind between Chinese and Japanese air forces, and – certainly not least – a re-escalating civil war in Iraq.
Still, markets have not been much impressed by these events. Even crude oil is still trading below its highs in 2013, 2012 and 2011. The next “bad news” would have to be really bad to scare investors and predicting an unexpected major global crisis is rather difficult, to put it mildly. At any rate, a further escalation of geopolitical clashes within or among the larger economies does not seem realistic in the near term. As cynical as it may sound: markets can quickly learn to live with numerous issues in the global arena, and the odds are that they will continue to accept a certain level of conflict and tension, as they always have.
What is more likely to happen, however, is that, the next earnings season, beginning on 8 July, will once again mostly surprise on the upside, and thus help mitigate ever-present valuations concerns. The fact is that analysts remain on the cautious side, despite an unbending and long-lasting bull market, robust corporate profitability, and recently improved economic data. Expected profit growth for Western and Japanese firms has only modestly increased over the past year, and remains attainable.
At the same time, expectations versus the Emerging Markets have been scaled back significantly in some cases, while revenue growth forecasts are down in most markets, regardless of whether they are considered “developed” or “emerging” (see chart 1 on page 2 of the PDF for changes in growth expectations, and the table on page 4 for the current growth forecasts).
There are also other factors that point to the cautious bias among companies and analysts, at least with regards to the older markets. For example, analysts see a notable margin slump in Japan. While revenue forecasts for Topix firms have risen markedly from a year ago, the consensus expects Japanese corporate profit growth to lag behind significantly. This looks too conservative, given the example of the US in recent years, where margins continued to expand, or remained high, in the face of many warnings. Overall, current consensus expectations certainly continue to offer no cause for concern, as signs of exaggerated optimism are still rare. In short, rising equity prices remain underpinned by continued earnings growth – and that is what ultimately matters most in stock markets.
First, we show by how much today’s expected growth rates (of earnings and revenue) for the coming year differ from those of a year ago . Example: the expected EPS growth for the US for next year stands at 11.4%, which is just 0.1% higher than what analysts expected a year ago. This increase is modest, given actual profit growth in developed markets has in most cases been at least a few percentage points higher than expected in recent years, with the US most consistently beating forecasts. Most recently, actual earnings in the Eurozone varied wildly by sector and region, and were broadly in line with forecasts on an index level . However, in the US, Switzerland and Japan, earnings exceeded consensus forecasts by 4%, 17% and 57%. On the other hand, emerging markets missed forecasts by between 2% (China H-shares) and 32% (Brazil). Today, expectations are only modestly higher than a year ago for most developed markets. However, it remains to be seen whether the sharp cuts in some emerging market forecasts will suffice to help companies from these regions finally beat expectations. It is also worth noting that forecasts for China have risen the most, which might also prove disappointing given current trends.
Second, we use the 10-day movingaverage levels of the Citigroup surprise indices to filter out the volatile daily noise. A rising index means that the number of positivesurprises is increasing and/or that the number of negative surprises is decreasing. We can that, in early April, US data flow began to improve first. Followed by Japan about a month later, and then by the rest of Asia Pacific. This month, finally, the Eurozone has also started to stabilize as well. It is worth noting that the recent positive change in the data flow coincides with the rekindled upward momentum in the international equity markets.