Are equities right this time?

Equities 5 minutes to read

Peter Garnry

Head of Equity Strategy

Summary:  The biggest question right now is whether equities are right and that the global economy will shortly move into the recovery phase and with it profit growth? Or are we seeing one of the biggest disconnects in recent memory? That's is what we are trying to answer in today's equity update. We are also talking about the massive substitution effect from bonds and into minimum volatility stocks.


Risk-on is coming a bit off today but global equities remain close to all-time highs despite dismal macro reading coming through and earnings growth expected to dip into negative this month. South Korea’s President Moon delivered today a depressive outlook for the economy and the statement is backed up by South Korean exports down 20% y/y again in October (the first 20 days). As the South Korean economy has been one of the best leading indicators on the global economy since 2008 this data holds a high weight in our decision-making and judgement of the global economy, and even more so of the Chinese economy. Outside the narrow scope of South Korea, the global trade volume data released by CPB shows the worst global trade environment since 2009 when the economy was still healing from the financial crisis in 2008.

Strong equities can only be explained by massive substitution effect from low real rates on bonds and strong beliefs among investors that policy makers will engineer a rebound to come in 2020. But this is a high stake poker play and something we alluded to in our equity update yesterday. US equity valuations are moving into danger zone given the macro backdrop, falling profits and the fallout from potentially higher rates. But maybe everyone outside equities are just wrong and equity investors are right this time. Given equities are a long duration asset class forecasting its returns and valuation is difficult, so don’t be too optimistic on the behalf of equity investors.

Yesterday we talked about the substitution effect from bonds into stocks with robust dividends and price performance. Today we are accompanying this with a chart to illustrate the effect. The shaded areas show periods of significant rise in the among of negative yielding bonds. In both periods, but especially the recent one, minimum volatility stocks have seen their valuation multiples expansion way beyond S&P 500. This is a sign of substitution effect away from bonds and into supposedly safe stocks. However, this substitution effect comes with risk as the move makes the minimum volatility factor trade more crowded and too such an extent that some observers of equity factor returns are sounding the alarm. With US minimum volatility stocks trading at a 29% valuation premium to S&P 500 which trades at a 40% valuation premium to global equities ex. North America you get the picture of just how expensive this segment is.

A key driver behind the stock US equity market has been a relentless upward move in EPS which has been driven by both higher nominal net income but also lower outstanding shares as companies have bought their own shares. This stands in sharp contrast to European equities that have used the equity market for issuances on a net basis. According to Goldman Sachs aggregate buybacks in the US will fall 20% in 2019 which means that one of the strongest marginal buyers of equities is holding back. On balance this is not good news for US equities.

The earnings season is in full swing and the results are slightly better than expected from Novartis, UBS and AMS, and forward EPS estimates on S&P 500 were raised a bit yesterday. In extended trading last night, Halliburton was the stark reminder of the worsening environment for energy stocks as the company issued a bleak Q4 outlook. The most important US earnings today are UPS, United Technologies and P&G each delivering insights into the logistics, industrial and consumer sectors of the economy. But for overall equity sentiment and the attempt to make new highs in the S&P 500 Index the key earnings this week to watch are those from Microsoft (Wed, aft-mkt) and Amazon (Thu, aft-mkt). Our views on Amazon and what investors will focus on were published yesterday.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
- Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)

Saxo Bank A/S - Representative Office
Boulevard Plaza - Tower 1
30th floor, office 3002
Dubai Downtown, Burj Khalifa area
Dubai
UAE

UAE

Trade responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.