Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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Weaker USD and ECB next week to extend risk-on in equities
Peter Garnry
Chief Investment Strategist
Summary: News that US and China to hold trade negotiations in early October combined with weaker USD and positive anticipation of central bank moves the next couple of weeks are driving equities higher. S&P 500 is breakout out today and looks to strengthen further if the USD weakness persists. In today's equity update we also take a look at Slack and Starbucks both disappointing on their fiscal year outlook.
The current risk-on sentiment seems to have three drivers. US and China are to hold trade talks early October in Washington which has lifted general sentiment and the outlook for tariffs not being hiked again in October. USD weakness which especially accelerated yesterday partly due to flow reversion in GBP extending into other pairs is easing financial conditions and lifting emerging markets.
There also seems to be a green shoot element in the DAX futures momentum as traders are betting on Germany to increase government spending, as South Korea has recently done, and lately a rebound in some key manufacturing indices in Sweden which like Germany is a high beta country to global economic activity.
One asset class not supporting our current view of a short-term rally here in equities is gold with spot only inches away from the recent highs. Gold spot is down today but not by the magnitude if this was a one-way street in equities. Also, some credit spreads are also higher the last couple of weeks.
First the DAX and now the S&P 500
The initial breakouts from tight trading ranges happened in FTSE 100 and DAX futures driven initially by weaker GBP and EUR. In the last couple of trading sessions, the momentum has continued without the help from weaker local currencies reinforcing real price action for all the reasons mentioned above.
S&P 500 futures have the breakout crowd today pushing through the 2,945 resistance level that have been the blocker for weeks. With current events that have unfolded over the past week we see momentum extending from here in US equities. Weaker USD is key to fuel the move. A surprise tiering system announced at next week’s ECB meeting could be a massive catalyst for markets as it would elevate European equities across the board.
Fundamentally S&P 500 is around 0.7 standard deviations expensive across nine valuation metrics. However, using data since 1991 the 10-year forward real return annualized is estimated 2.8% which is still higher than offered in many bond segments of the market.
S&P 500 profit growth
EBITDA growth y/y in S&P 500 remains high at 7.7% but given the strong USD, slower growth in the world and many key macro indices are we expect EBITDA growth to come down meaningfully over the coming quarters. Depending on central bank outcomes the next weeks and US-China trade negotiations it might not be a problem for the overall index but beneath the surface a sharp slowdown in EBITDA growth is typically a bloodbath in some key segments of the market. We expect technology hardware, semiconductors, materials and industrials to be the negative surprise here.
Stocks to watch
Slack Technologies (WORK:xnys) shares were down 13% in extended trading despite a Q2 beat on revenue and EPS, and an upward revision to its FY revenue guidance. It was the company lower FY EPS guidance that disappointed as investors clearly want to see a faster path to profitability as the valuation is extremely stretched with a trailing EV/Sales ratio of 29.x. Slack has generated negative free cash flow of $117mn in the last 12 months a significant worsening from a year ago.
Starbucks (SBUX:xnas) shares were initially down yesterday as the US coffee chain adjusted its FY20 outlook seeing EPS growth below the long-term growth target of 10%. Compared to the outlook presented by Starbucks in previous investor presentations their growth is significantly diverging from expectations. The key risk for Starbucks long-term growth plans is the relationship between China and the US. If the relationship worsens it will also have a negative impact on US companies’ ability to do business in China. Technically the 92.50 level is crucial for support here as it’s the gateway to a major gap. For now, there are many technical buyers of Starbucks shares as minimum volatility and momentum ETFs are long Starbucks.
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