Mid-Year Outlook: Earnings to Continue Supporting Stocks

• Dr. Jan-Carl Plagge, Head of Applied Research
  

Global equities are likely to extend their march higher in the second half of 2017, led by the Eurozone and emerging markets, with monetary policy remaining a source of potential volatility, according to strategists.

Synchronized economic growth in all major regions and central banks’ gradual withdrawal of monetary stimulus will be supportive of risk assets, say strategists at major asset managers and banks including UBS Wealth Management, Goldman Sachs Asset Management and BlackRock. European equities, in particular, will be underpinned by earnings recovering from years of recession, they add.

“We see a broad-based recovery on both the economic and the corporate fronts, across regions,” Rolf Ganter, Head of European Equities at UBS Wealth Management, said in an interview. “Fundamentals are really good, valuations are still not excessive and while our base case remains central banks might edge away from easing, they will not withdraw sharply. The path of least resistance for these markets is up.” UBS Chief Investment Office is ‘overweight’ global equities in a multi-asset portfolio.

While geopolitical risks remain, investors appear more focused on the path and pace of the expected ‘normalization’ of US and Eurozone interest rates. The Federal Reserve is likely to unveil a plan in September to shrink its balance sheet, and the European Central Bank (ECB) may announce the same month a reduction in asset purchases for early 2018, according to Goldman Sachs.¹

Eurozone equities’ allure versus US

Even after gaining 23% in the year to Jun. 30, 2017, the EURO STOXX 50® Index has further to rise to match the performance of US stocks in the aftermath of the global financial crisis (Chart 1). Since 2007, the STOXX® USA 900 Index has doubled in value, while the benchmark for Eurozone equities has climbed 16%.

Valuations also look attractive for European equities relative to their own history and to U.S. stocks (Chart 2). While the price-to-earnings ratio for US stocks has increased consistently in recent years, that of Eurozone stocks has declined since 2014, first as shares fell and more recently as earnings growth picked up.

Eurozone profits are re-emerging following years of contraction. Earnings before taxes and other items for the EURO STOXX 50 will expand 12% this year, according to single-stock forecasts collected by Bloomberg. They grew 4.1% in 2016, the first increase in four years.

The Eurozone’s gross domestic product (GDP) is expanding at an annual rate of 2%, the fastest since 2011.

For BlackRock, equities in Europe, Japan and emerging markets have the most promising outlook.² The firm says that the ratio of analyst upgrades to earnings estimates is at a five-year high. French bank Societe Generale highlights Japan as the possible surprise for coming quarters, saying that the country’s growth and inflation rate may finally accelerate as a result of structural reforms and ultra-easy monetary policy.³

Firmer inflation and the effect on US bonds

Goldman Sachs expects US interest rates to increase by 100 basis points through 2018 – compared with around 40 basis points currently priced in the market. This, coupled with a rebound in US inflation, will weigh on US government and corporate bonds, the asset-management firm’s strategists said last month.

Fixed income markets have benefited from continued low rates as inflation has fallen behind policymakers’ targets. Yields on 10-year US Treasuries fell in the first half of 2017, to 2.30% from 2.44%, even as the Fed lifted the key federal funds rate twice in the period. Any pick-up in market rates will depend on whether inflation in developed economies, and principally in the US, breaks out from current subdued levels, strategists say.

European fixed income markets sensitive to ECB’s move

The Eurozone corporate bond market was little changed over the first half, even if prices fell in the final week as comments from ECB President Mario Draghi were taken as signaling that the region’s extraordinary monetary stimulus and bond purchases may soon be rolled back.

Deka, the German bank, sees volatility ahead for European credit as the ECB is likely to taper bond purchases next year. However, debt prices should be supported by ongoing strong economic and corporate fundamentals, the bank’s strategists said.

“In the first place, an interest-rate turnaround would be very carefully implemented and, secondly, corporate bonds would be handled very gently,” Deka wrote in a report.⁴ “Moreover, corporates have been underpinned by good economic data that have been increasingly reflected in positive profit reports.”

Strength in euro has legs, Deutsche Bank says

This year’s jump in the euro has further room to run, according to Deutsche Bank. Strategists at Germany’s largest bank expect the common currency to reach $1.20 by 2018, because of technical moves, the continent’s economic momentum and a stronger political leadership for the European Union following the election of Emmanuel Macron in France.⁵

UBS Wealth Management, whose bullish forecast on the euro at the start of 2017 went against consensus, also sees the bloc currency reaching $1.20 in the next 12 months. The euro has climbed to $1.17 from $1.05 at the start of 2017.

The fate of the dollar, however, will also be tied to the evolution of US politics, and whether President Donald Trump will be able to fend off opposition and pass through much-awaited policies to stimulate the economy.

Featured indices

EURO STOXX 50® Index
STOXX® USA 900 Index

¹ ‘Quarterly Investment Outlook,’ GSAM, Jul. 24, 2017.

² ‘Global Investment Outlook – MidYear,’ BlackRock, July 2017. 

³ ‘On a plateau,’ SGCIB, Jun. 12, 2017.

⁴ ‘Economic Forecasts – July / August 2017,’ Deka.

⁵ ‘The House View,’ Deutsche Bank, Jul. 25, 2017.