Chief Investment Strategist
Summary: Despite the probability of a global recession is alarmingly high equities continue to be bid this week as investors are clinging to a positive US-China trade deal narrative, Brexit breakthrough and an earnings season that will completely disappoint. Our view remains that equities could suffer a sizable drawdown in Q4 driven by "kitchen sink" behaviour in the upcoming months and earnings releases. The US-China trade deal seems also to be on thin ice and could create havoc to equities at anytime.
Global equities are higher following yesterday’s confusion over the US-China “first phase” trade deal, that includes China buying $50bn in US farm products most notably soybeans, as China’s government wants more talk before signing the trade deal. Our view remains that there will not be any comprehensive trade deal between China and the US inside the current US presidential period.
In Europe, the prospects of a potential path to a Brexit deal on top of better than expected ZEW survey are leading the way for equities up 0.6%. The Euro STOXX 50 Index is flirting with the highs going back to Q2 2018 and there are multiple arguments for being long European equities although we think it’s too early. If we are proven right on a weaker real USD this will play into European equities relative to US equities. Also, European equity valuations are attractive, but for obvious reasons of low growth and general poor capital efficiency by European companies, which means there is value to found. If investors couple these two factors with a potential global economy moving into the recovery phase of the business cycle within the next couple of months, then European equities could become the best trade among equities in 2020.
Staying with Europe the continent is seeing low growth and brewing recession in manufacturing sensitive countries such as Germany and Sweden. Willingness to do more fiscal stimulus is still low due to existential risk and shock that followed during the Euro crisis of 2010-2012. But Europe might have a deeper problem rooted in Germany’s complex economy. John Authers had a great Gadfly piece yesterday in Bloomberg that presented a recent study from the Growth Lab at Harvard University that indicates that Germany might have maxed out its economic potential. The study used data from the Atlas of Economic Complexity (MIT) showing that Germany has a high degree of economic complexity and has virtually exploited all major existing products meaning very little room for economic growth outside heavy innovation and new product categories. This means that Germany must reinvent itself which will bring about its own disruption to its economy.
Another equity market that is seeing momentum is Japan with the Nikkei 225 close new highs for the year despite worsening leading indicators on the economy. The weaker JPY has recently added fresh support to the equity market in local currency but also a positive prospect for a US-China trade deal is a positive for the Japanese economy which has suffered from the trade war.
The earnings season starts today in the US with the most important earnings to watch from JPMorgan Chase (11:00 GMT) and Citigroup (12:00 GMT). JPMorgan Chase is expected to lift Q3 EPS to $2.46 up from $2.36 a year ago driven by their market leading position and diversification across multiple business segments. A negative surprise from JPMorgan Chase would not be a big surprise given the low volatility, low investment bank activity and lower rates. Citigroup is important to watch due to its exposure to emerging market countries. This gives clues to sentiment in arguably the most hard-hit part of the global economy due to the manufacturing slowdown and strong real USD.
Our overall view is that global earnings growth will go negative in the fourth quarter and that the outlook presented in Q3 earnings releases will be that of high uncertainty. In Friday’s equity update we showed which sectors that have been hit the hardest over the past year which are the energy, financials and materials sectors. But for equity indices the two most important sectors due to the market value weights are health care and information technology which both have hold up well the past year.
As sentiment on technology stocks is important tomorrow’s earnings from Netflix is this week’s most important earnings release. Analysts are looking for 31% y/y revenue growth and EPS growth of 40% y/y. This sounds impressive to most and surely net positive for the stock, but this is already in the price and investors will only react to subscriber growth figures most notably in its international markets. We expect Netflix to continue being cash flow negative the company’s outlook could suffer from a warning due to more intense competition.
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Chief Investment Strategist
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Chief Investment Strategist
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Chief Investment Strategist
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Chief Investment Strategist
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