Market Insights – 29 october 2018

Each week, a team of experts shares its market views with you.

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Sunrise view of Copacabana and mountain Sugar Loaf


Italy was once again in the limelight – this time because the European Commission rejected its 2019 budget. Yet Italian sovereign yields declined over the week, which leads us to believe that investors had expected this outcome. We don’t think Italy will have to pay a fine for violating the EU’s budget rules.

Angela Merkel suffered more heavy losses in regional elections in Hes-se, another sign that her govern-ment is crumbling. Just like in the Bavaria elections, her party lost ground to more extremist parties such as the Greens and the AfD. Merkel reacted immediately and stepped down as leader of her party. She also announced that she would leave politics in 2021, creating an uncertain future for Germany.

Unsurprisingly, Jair Bolsonaro won Brazil’s presidential election. Despite his controversial statements and his rather provocative personality, the Brazilian stock market reacted well to his victory and his pro-business stance. The country’s Bovespa index continued to gain ground, up more than 22% since its June low.

Will we soon run out of reasons to sell equities?

Last week – and October as a whole – has been particularly trying for stock-market investors. For a long time, US stocks seemed to be resisting the bear-ish attitude that took over emerging stock markets and then European equi-ties. But the US stock market finally cracked in early autumn and has lost almost 9% this month. Among the world’s major indexes, only those for Japan and the emerging markets fared worse, while Switzerland’s SMI dropped just 5% thanks to its very defensive make-up. What’s more, the reasons for these massive sell-offs have changed drastically over the month. A few weeks ago, investors were fretting that the US economy would overheat, sparking a surge in inflation and prompting the Fed to more firmly tighten its monetary poli-cy. Others were concerned that the re-cent uptick in energy prices or the rise in long-term yields could be major risks for the economy and equity markets. But these fears have since subsided. While US GDP growth was slightly stronger than expected in Q3 (3.5% on an annual-ised basis) inflation remains under con-trol, with the GDP deflator at 1.7% (an-nualised). And oil prices and US long-term yields have both dropped back to levels that no longer constitute a threat to economic growth. Surprisingly, the rea-son for US stock markets’ bout of weak-ness last week is that investors are wor-ried that economic activity may slow too quickly in 2019, which would have a knock-on effect on corporate earnings. This abrupt change of opinion regarding the US economy is hard to explain and could be the start of a market capitula-tion. The recent downturn has brought stock prices back to levels that are rea-sonable in the USA – where the P/E ratio is at 15 – and even attractive in European and emerging markets, where P/E ratios are close to 10–11. The earnings season is not over in the USA and could spark more volatility on the markets. But our indicators suggest that investors are extremely bearish on equities, and we think that stocks are oversold and could rebound in the short term as a result.

A little more patience...

Almost half of the companies making up the S&P 500 have now published their results. And it’s fair to say that the strong earnings figures were not enough to reassure investors, who seem much more worried about the earnings growth outlook for next year than the trend over the past three months. Although 82% of companies beat their earnings consen-sus estimates, it’s the forward guidance that’s weighing on the market. Both manufacturing groups, like Caterpillar and 3M, and internet heavyweights, such as Amazon and Alphabet, have been surprisingly cautious about the months to come. Analysts were perhaps too complacent and overly optimistic in their earnings growth forecasts for 2019, and these expectations are now being re-vised downwards. Once investors have adopted a more realistic stance about 2019 earnings growth, we think stock markets may be ready to rebound.
Every chart and sentiment indicator is heading towards extreme levels, which suggests that an upturn could soon be on the cards, at least technically speaking. However, more than 130 US companies are still to publish their results this week, and the latest manufacturing PMI figures will be released as well, so we recommend waiting a little while longer before seizing the numerous opportunities arising out of this healthy market correction.

To go deeper


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