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Investor Sentiment vs. Economic Fundamentals

, April 19, 2019, 0 Comments

Conflict between sentiment and hard data is not unusual but is already looking like the biggest challenge for investors in 2019. Real activity Index chart  comes from the collaboration on global economic data between the Financial Times, Eswar Prasad of Brookings and Ethan Wu of Cornell to publish every 6 months Tracking Indexes for the Global Economic Recovery (TIGER).


Figure 1:Tracking Indexes for the Global Economic Recovery (TIGER): a tiger not burning bright

The latest report was published on Sunday and it confirmed that the synchronised growth until recently trumpeted by the IMF is rapidly slowing. Last week I suggested that bullish investors are having to brave a rather depressing succession of official data from around the world. This week they face a new wall of numbers: notably, on inflation and industrial production in the US, Euro Area and India plus Trade and New Loans from China. There are Small Business and Consumer Confidence surveys from the US while the UK reports on the all-important Services Sector and shop sales. Only an unexpected surge in global manufacturing could brake the slowdown in hard data.

Also this week will come the latest batch of platitudes from the ECB accompanied by no changes in the main policies. Potentially more interesting will be the latest FOMC Minutes, which could, despite being cloaked in well-honed words, reveal the absence of ideas on what to do next. On top of all this, there is the latest Quarterly Economic Outlook from the IMF, which was published earlier today.


Figure 2: S & P 500 since May 2017: would you start from here?

Meanwhile, most equity markets have been accelerating in the opposite direction to global hard data. All the major indices are up year-to-date in 2019 with Shanghai the runaway winner at around 30% as it has returned to favour, thanks to the planned (still quite modest) increases in China A shares’ weighting in the MSCI indices and an intensified hunt for yield. European equities, notably and surprisingly French and Italian banks, have also benefited from global investors’ seeking alternative opportunities. Nevertheless, the pace continues to be set by US markets where momentum investors have fought back after their drubbing last October and December and taken the Tech Sector to new record levels. Intriguingly, the energy and consumer staples sectors have also been gaining, which points to more defensive buying by institutional investors. Figure 2 shows the dramatic turnaround in the S & P 500 since just after Christmas, which has taken it all the way back to the previous peak in January 2018. The question inevitably now arises as to whether prices can keep rising through the Q1 results season that begins as soon as Friday. Yet again sentiment and fundamentals are set to clash.

The consensus based on companies’ guidance and analysts’ forecasts is that both revenues and earnings will have been quite sharply lower in Q1. Accordingly, investor sentiment will be driven by how much worse or better than consensus are the actual results and the prospects for recovery later in the year. Recently negative results have been punished much more than both in the past and also much more than positive results have been rewarded. Looking at Figure 2, investors might not wish to start a new cycle at these levels and opt instead to sit on the fence until a clear pattern emerges over the next few weeks. Another potential restraint on sentiment could be disillusion amongst institutional investors with the central banks, although many will be reluctant to become apostate after benefiting from years of manna from Heaven in the form of QE and low interest rates.investors-fundamentals-emerging-markets

Figure 3:Falling confidence does not help the bulls

So, if hard data is slowing, what about soft data in the form of Consumer Confidence, Purchasing Managers’ and other business surveys indices, which can be very useful in identifying trends?. Alas, overall the surveys are broadly consistent with the hard actual numbers being reported around the world, as shown in a helpful composite from the FT (Figure 3). Business surveys in the US are generally stronger than those elsewhere but also quite erratic and the same is true of Consumer surveys, which is why this week’s flash report from Thomson Reuters/University of Michigan will have to be very strong if it were to move stock prices. China’s surveys remain subdued, which is quite revealing in the context of other official data, while Japan’s becalmed surveys reflect the economy as a whole. The Euro Area’s consumer and business (especially manufacturing) surveys are still sliding, led ominously by Germany, while Brexit has understandably cast a dark shadow over surveys in the UK.

Today’s new forecast (Figure 4) from the IMF of World Output of 3.3% is 0.4% lower than the previous full forecast in October, reflecting falling business confidence, trade disputes and political uncertainty in many economies. The forecast for 2020 was also cut by 0.1% to 3.6% but with a high risk of further downward revisions. It seems churlish to doubt these forecasts when so much effort and expertise goes into their preparation but they are best regarded as illustrative between different economies and directional rather than precise. They also have an aspirational aspect when it comes to Developing Economies and the latest forecast is clearly giving both China and India the benefit of the doubt. In contrast, President Trump will not welcome the trimming of the outlook for the US GDP growth to 2.3% this year and 1.9% for 2020, although the this is consistent with both the trend since he took office (apart from the tax-cut spurt in Q2 and Q3 last year) and the latest GDP Nowcast from the Atlanta Fed.investors-fundamentals-emerging-markets

Figure 4:IMF latest 2019 forecast: slower again

It seems very clear that the macroeconomic fundamentals are not encouraging for equity prices but what about market fundamentals? I have selected 5 charts that highlight the challenges. Once again I have to concentrate on the US as any major moves there would have a knock-on effect on both other equity markets and the various bond market sectors. A correction in the US would make some investors look for safety and the more adventurous seek higher yields elsewhere, as happened most recently in Q4 last year.investors-fundamentals-emerging-markets

Figure 5:Doing well out of the Great Financial Crisis

Figure 5 from Goldman merits a note all on its own but here I want to focus on the wide range of returns from different asset classes since January 2009 and contrasts them with the cumulative movement in economic trends in the US and EU such as GDP, inflation and wages. This confirms that asset prices have run far ahead of the real economy, especially equities led by the S & P 500’s growing by almost 250%, all Advanced Economies’ (MSCI World) at over 150% and Europe 600’s (SSXP) at just under 150%. Also scoring very strongly are European and US High Yield Bonds. The obvious link with Fed and ECB QE programmes and low interest rates suggests that these asset prices, even if currently accepted by investors, are vulnerable to changes in expectations for central bank policies.investors-fundamentals-emerging-markets

Figure 6:Russell 2000: great expectations

Figure 6 is about companies in the Russell 2000 Small Cap Index, most of which are not small in comparison to other markets. This Index is up over 17% so far in 2019, outperforming even the S & P 500 and so it comes as something of a surprise that not only are more than 60% of the constituent companies not profitable but also that the average expected 12-month forward EPS is over 60. Good luck with that!investors-fundamentals-emerging-markets

Fiqure 7: Buybacks overtake dividends

Figure 7 was published in order to show decline in importance of dividends and the rise of share buy-backs and this may help to explain why high dividend payers in the Real Estate, Energy and Utilities Sectors have been relatively out of favour. Since the 1980s, after the SEC permitted buy-backs, companies have sought to take advantage of weakness in their share prices and this clearly contributed to the high returns in the two decades before 2000. Since the Dot.Com boom there has been an increase in the number of executive compensation packages linked to share prices, which may have prompted less felicitous buy-back programmes (notably in 2007, 2008 and perhaps 2017 and 2018). What seems most surprising about Figure 7 is how it suggests that capital appreciation since 2010 has been running at a lower level than in the 1950s, 1980s and 1990s despite the disastrous impact of the Great Financial Crisis. This is surely one for the bulls!investors-fundamentals-emerging-markets

Figure 8: Is Q1 really only a blip?

We are about to start finding out but the consensus is that Q1 was not good for either top line sales or earnings per share. JP Morgan and Wells Fargo will be amongst the first majors to report. As mentioned above, investors have become less forgiving of companies that bear ill tidings, particulary about the future. As a financial analyst Oscar Wilde might have written: bad news for one quarter may be regarded as a misfortune but bad news for two or more looks like carelessness.investors-fundamentals-emerging-markets

Figure 9: A new golden age?

Chartists are among the most vocal bulls and Figure 9 highlights the latest Golden Cross in the S & P 500 with the 50-day moving average (red line) rising above the 200-day average (blue line). The yellow areas indicate the previous periods when this has been the prevailing situation. I have to confess to finding it difficult in such charts to distinguish between chickens and eggs but it does seem clear that the index (black line) goes up once a Golden Cross occurs. The narrow grey area at the extreme right of Figure 9 covers the routs in last October and December and a new yellow area has begun. In fact, quite steep bounce-backs in the months following corrections are quite common but after 3 months the current rally is already at the top end of the range. Chartists will have taken note and many algorithms will have been written in anticipation of the Q1 earnings season.investors-fundamentals-emerging-markets

Figure 10:Apocalypse now? Perhaps not!

I could not resist the latest Hedgeye cartoon as it very nicely illustrates my own overall conclusion. The End is Not Nigh even if the global economy is slowing and markets are not facing imminent collapse. However, share prices cannot keeping rising if company profits are falling or even merely static. There will be winners and losers, some on a spectacular scale.The huge amounts of money invested in passive funds will exaggerate the impact. I cannot help feeling that we face a period in global markets of high risk and low returns.


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