Global growth continues to show positive signs, confirming the debt deflation cycle is rolling over to a more traditional industrial cycle. Global PMI data has retracted slightly, but continues to support the first synchronised global growth cycle seen in many years and this is being reflected in strong earnings growth. However, geopolitical risks will continue to weigh on the market. The Trump initiated trade dispute is ongoing as the US continues to introduce new trade tariffs.
In China, the 19th Party Congress charted a course that involves less pollution, less reliance on property construction and further increases in the services sectors that should result in a more balanced economy. The expectation is that over the next five years, fixed asset investment will slow and GDP growth will move from around 6.5% to circa 5% as China’s economy becomes consumption driven.
During the latest reporting season, high growth, high PE names were squeezed higher, often on poor results and outlooks. It seems the market is becoming lost in its desire to chase growth, with little or no attention to the price they are paying. The divergence between value and growth stocks has been widening over the past five years and has certainly picked up over the past 12 months. This reporting season has seen this divergence take a further incredible step up with the top PE quintile stocks expanding their 1 year forward PE by a further 10%, despite earnings in fact falling by 2-3% on average.
We maintain our view that a retracement of this bubble-like trend must be a high probability given the extreme levels we are seeing. We believe that the rotation towards cyclicals and value, albeit stalled, still has some way to go and should be driven by rising global inflation, and therefore earnings growth in the more economically-sensitive sectors.
Source: Brad Potter – Nikko Asset Management
