Market Outlook – May 2018

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. While tensions over North Korea’s missile testing program have eased somewhat as relations begin to thaw, a Trump initiated trade dispute is on the rise after the US introduced new trade tariffs sending jitters across markets.

In China, the 19th Party Congress has 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.

Our view is 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. Comments from both the US Federal Reserve and European Central Bank suggest they are on a path of reducing their balance sheets. This is likely to put further upward pressure on bond yields, despite some central banks maintaining quantitative easing programs.

The current market PE ratio appears slightly cheap based on the average of the past 20 years of low inflation. It appears we have entered into an earnings expansion phase that could last many years. The typical earnings expansion results in rising markets and falling PE ratios. Under-earning and undervalued stocks typically do well in the early stages of such a recovery.

Source: Brad Potter, Nikko Asset Management