Seek Risk as Earnings and Valuations Trump Trade Risks

Author:
Michael J. Kelly, CFA
Global Head of Multi-Asset
New York

8 August 2018

An array of cross-currents confront global markets, but on balance they appear positive. While trade-related risks have risen, valuations have reset, financial conditions remain accommodative, and China has provided a growth backstop. We remain constructive on global markets, with a generally bullish stance over the intermediate term.

Last month, good news came in the form of earnings that continue to confirm broad global momentum, with exceptional US strength and weaker, yet still healthy, earnings growth outside the US. Trade tensions have weakened confidence in pockets of Asia and Europe, yet not in the US. China, in a reversal of its deleveraging stance, now supports tariffs, currency weakness, and monetary and fiscal thrusts. Domestic growth has become a priority to build a buffer against trade, yet re-leveraging China is risky and cannot go on for long given the high degree of existing leverage. Heightened US-China trade tensions, while providing a respite in US relations with the European Union and Mexico, are a negative. 

Trade will remain the dominant short-term risk for markets, although we see it morphing into a positive force for global growth over the intermediate term. We still believe that revisiting the global trading regime, despite producing short-term tensions and more incremental tariffs than we expected, ultimately will lead to more reciprocal and lower overall trade barriers. Until then, the risk to watch is the degree of trade-tension spillover into corporate confidence, which could mute or even derail the next investment-driven leg of global growth. It’s still early, but the spillover risk may be contained by indications that companies are able to re-route supply chains relatively quickly. 

Our bottom-up sources are providing encouraging confirmation of the global corporate investment cycle broadening beyond energy. The previous absence of investment across multiple sectors at the same time that new technologies have been developed that enhance productivity, flexibility, response times, and margins all bode very well for stepped up investment. Meanwhile, measured productivity – after hovering around 0.5% during much of the post-crisis period – already seems higher, having jumped to 1.5% in the latest US GDP report.

Overall, while strong earnings growth globally marked the first half of 2018, markets have sold off since February. Together, this has compressed valuation multiples and made the risk/return tradeoff more attractive. To our eye, it is the sustainability of above-average growth that markets are mispricing most.

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