Head of Equity Strategy
Summary: The disconnect between macro data and equity markets seems to be growing as equities are making new highs despite weaker macro data and earnings growth going negative in emerging markets and close to negative in developed markets. Equity investors are clearly discounting a soft patch in the economy before returning to trend growth. Our view remains that of being defensive.
October was a mercurial month with global equities rising 2.7% in USD terms despite clear evidence that the global economy continues to slow down. In fact, the global leading indicators from OECD have been declining for 20 straight months. The US chemical industry shows weakness to persist into Q2 2020, South Korea export data shows little signs of rebound in Asia and in particularly China, US employment is slowing down, and earnings growth has gone negative in emerging markets and close to negative in developed markets. The disconnect between what we observe in macro data and equity markets has many explanations but one of them is that equity investors are only discounting a soft patch for the economy before returning to trend growth. This is key assumption so any broad-based weakness in the US services sector and employment in general should in theory in set in motion a repricing of global equities.
This year’s 19% rally in global equities has been fueled entirely by expanding valuation multiples which to some degree can be justified as global interest rates have come down reflecting lower inflation and growth expectations. We observe a clear pattern of lower inflation rate translating into higher valuation multiple. This reflects lower hurdle rate for return on capital for companies but also substitution effects from bonds into dividend paying stocks, something we have talked a great deal about during October in our daily equity updates.
In our Q4 2019 Outlook: The Killer Dollar we also showed how the USD is a key driver of equity returns globally. Our findings suggest in the last three major USD cycles that stronger USD coincide with strong US equity returns compared to developed equities ex US and emerging markets. The stronger USD theme is also important to be watching as the USD is a constraint on financial conditions and global growth. For the time being we remain defensive on equities but will switch to overweight as soon as leading indicators are turning higher again and the USD is weakening.
Given the trajectory of macro data, the geopolitical uncertainty on the rise and a bumpy ride on the trade deal we still have the view that volatility could pick up in November and December although this seems like a contrarian view as equities are climbing higher. The VIX is back to levels around July before the August volatility kicked in. In our view equity volatility is fragile to news on the US-China trade deal and US jobs data out today.
AI: The good, the bad, and the bubble
While a deep recession may not be iminent thanks to central bank policy, interest rates will have to stay high for longer, and this will be accompanied by volatility risk from the unwinding of bubbles, especially within AI.
Steen Jakobsen,
Chief Investment Officer
The emergence of advanced AI systems is by far the most surprising event this year, turning everything upside down, while risks and benefits are debated. AI will also become an arms race between the US and China.
Peter Garnry,
Head of Equity Strategy
As China navigates global fragmentation, its cycle of technology application, productivity enhancement, and growth is threatened by US breakthroughs in generative AI, limited computing power, and geopolitical tensions.
Redmond Wong,
Market Strategist
Japan’s expertise in semiconductors and robotic integration could be the foundation of AI dominance. Combining two of this year's themes, Japanese equities and artificial intelligence, brings a wave of opportunities.
Charu Chanana,
Market Strategist
The AI fever has turned the technology into a darling, pushing crypto further into no-man’s-land. There are striking similarities between AI and crypto, and if these are to come full circle, AI won't be spared for bubbles.
Mads Eberhardt,
Cryptocurrency Analyst
Stocks related to artificial intelligence (AI) have appeared on investors' radars. Expectations are high, but it may be necessary to consider how to get exposure to AI in a diversified way.
Hans Oudshoorn,
Trainer Academy
The USD is on its back foot as markets celebrate an eventual Fed rate peak and steady long US yields. The stakes are even higher for the Japanese yen if longer major sovereign yield curves have to price in economic acceleration.
John J. Hardy,
Head of FX Strategy
While commodities, broadly speaking, have faced some tough months, a partial reversal during June could signal that the asset class is getting back on its feet with energy holding up and precious metals with upside potential.
Ole S. Hansen,
Head of Commodity Strategy
As inflation remains high central banks face hard decisions about whether they should keep hiking interest rates or stop. Meanwhile, the rise of AI creates bubble-like conditions that only make the decision harder.
Althea Spinozzi,
Senior Fixed Income Strategist
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