By Hottinger Investment Management
World Cup fever and trade wars made for an exciting July within the financial sector just before the usually quiet days of August as the majority of the industry goes on vacation. This can lead to much lower volumes causing higher volatility should important events ignore the summer recess. For those left behind, investment opportunities can become apparent from unwarranted price volatility, but more often than not this is over-played.
The phenomenal strength of corporate earnings reported during quarterly earnings season was enough to push equity markets higher across the developed world. Over the course of the month, the S&P 500 gained 3.6% and European equities rose 3.5% and are now up on the year. Good economic news also pushed the 10-year US Treasury yield back towards 3% as the markets anticipated an August rate hike.
It is very difficult not to be impressed by corporate America with year-on-year earnings growth of 23.3% and growth in earnings of 8.7%; 91% of S&P 500 companies beat earnings-per-share (EPS) estimates and with regards to overall sales 74% of companies beat estimates. Despite the narrowness of stock returns that we have been discussing, especially the dominance of the FAANG stocks, there is nothing narrow about these statistics with all major sectors bar utilities seeing analysts raise forward guidance. As John Authers pointed out in the Financial Times, the FAANG’s have accounted for approximately 50% of the US stock market returns over the last 6 months, but it is still the fact that the number of stock price winners and losers overall is very similar.
European earnings have also impressed with 56% of the Euro Stoxx 600 Index beating EPS estimates and economic surveys in July suggest activity is stabilising at a level that is still consistent with growth of around 2%, which is above trend. Trade tensions eased between the US and EU after EU President Jean-Claude Juncker visited Washington adding to the good news surrounding equity markets. They agreed to work together and plans for new tariffs on other EU goods are on hold while talks take place. It is true to say that the bulk of the European recovery in financial markets was a 2017 story and European markets have been struggling this year with higher oil prices – Europe is a net importer of energy – and weakness in its chief exporting markets in Asia.
Brexit continues to dominate the UK headlines as the deadline for an agreement approaches. The market clearly remains nervous about the prime minister’s ability to strike a deal with Europe that will be sufficient to win a parliamentary vote. The continuing uncertainty is clearly affecting corporate investment and the cost of a weaker pound is also hitting the pockets of consumers. The FTSE All-Share gained 1.2% during July while the pound lost ground against major currencies over the course of the month down 0.5% vs the dollar and -0.67% vs the Euro. Despite general media marvelling at the strength of UK equities since the referendum the fact is that investment in foreign equities far outweighs the return in domestic markets. In sterling terms the S&P500 gained 4.1% in July to be up 8.5% YTD while European stocks returned 3.9% in sterling terms in July although YTD figures are very similar to UK stocks, up less than 1%. We note that a significant Brexit discount remains in the price of risk assets; we stand ready to respond should the outcome of the Brexit negotiations be favourable for risk markets.
Meanwhile Japanese equities only managed a 1% gain in July leaving the Nikkei 225 still down 0.7% YTD. While a case can be made for Japanese equities on a fundamentals basis, we believe that the currency risk remains too strong. The Yen’s safe haven status leaves it exposed to a deterioration of the trade skirmishes between the United States, Europe and Asia and until hostilities settle down, Japanese risk assets look unattractive. Trade relations between the US and China deteriorated further in July as the US government upped the rhetoric despite industry becoming more vocal about the impact of tariffs on trade. Having put the brakes on since the beginning of the year causing a noticeable slowdown in the Chinese economy the PBC cut the reserve requirement in July to encourage bank lending and the government announced a new package of fiscal policies that will affect many different Chinese companies. Ironically the 3% fall in the Yuan will help Chinese exporters overcome the effects of US tariffs which will do little to mollify Mr Trump.
India has become the single country globally to show the strongest economic growth (+7.7%) amongst large developing countries but, while emerging markets continue to provide a large part of global growth, financial markets will remain under pressure for as long as the dollar stays strong. The 6% correction in MSCI EM Index year to date is an indication of the effect of the dollar and the sharp slowdown in China this year but there are signs that equities markets are stabilising at current levels assuming there is no further deterioration in global conditions.
We entered the summer months feeling a little cautious regarding valuations and the ability of the global economy to continue at its current strength in the light of the extent of monetary tightening being undertaken and as such expect equities to be challenged in the second half of the year. We will, therefore, look to take some risk off the table in the medium term and increase cash balances in the expectation of more attractive valuations to come.
