Economic Outlook for June 2017
“Sell in May and go away” used to be a popular phrase on trading floors. By mid-May a correction in equity markets seemed indeed possible as the political problems for the White House escalated. Financial markets, however, proved to be highly resilient to geo-political factors and, after a very limited correction, the strong performance of global equities was ultimately extended to five months in most key markets (the US S&P500 index gained 1.2%, the DAX 1.4% and the Hang Seng 4.6%). Positive economic data and a surprisingly strong earnings reporting season (covering the first quarter) were, in the end, more important to investors’ confidence. Equity prices do not tend to advance in a straight line, and one cannot rule out a period of “profit taking” by investors, but the improving global economic momentum bodes well for a prolonged favourable earnings trend.
Europe is the star
Within the global context, Europe is starting to stand out with positive surprises. Although first quarter Euro area GDP growth was still merely solid, and unchanged from the end of last year (+1.7% year-on-year), leading indicators strongly suggest that one can expect an acceleration from the second quarter onwards. The so-called flash PMI (Purchasing Managers’ Index) stayed at 56.8 in May compared to April and at a six year high (values above 50 indicate expansion). In addition, the authoritative IFO Business Climate Index in Germany pointed towards an acceleration of business activity in its most recent survey, stating that “ the mood among German business was euphoric in May. The IFO Business Climate Index rose from 113.0 (seasonally adjusted) points last month to 114.6 points, the highest figure on record since 1991. Companies upwardly revised assessments of both their current business situation and their business expectations significantly”.
In view of the significant improvement in leading indicators it seems increasingly likely that European economic growth will converge with the US and one could foresee that major institutions upgrade their forecasts in the course of the year (even allowing for the uncertainty surrounding the effects of Brexit): The IMF currently foresees 1.7% GDP growth in the Euro area this year compared to 2.3% in the US (but predicts only 1.6% in Germany after 1.8% in 2016).
Clarity on USA monetary tightening
The US first quarter GDP growth statistic was upgraded to an annualized 1.2% (higher than the market expected) from the original 0.7% estimate. Although this still represents the lowest growth rate in three years, it was encouraging to observe that the upgrade is related to higher than estimated fixed investments and, importantly, a positive adjustment to consumer spending. In view of the first quarter evidence, economists were starting to wonder if the existing full year GDP growth estimates (ranging between 2 and 2.5%) would be achievable. The consumer spending statistics for April, however, suggest that the US economy is accelerating somewhat: April saw a 0.4% (month-on-month) advance and the March number was raised to 0.3% (previous estimate: zero). April's increase was the largest since December 2016 and, considering that consumption represents around 70% of US GDP, bodes well for economic growth in the second quarter when an annualized 3% growth rate now seems within reach.
The incoming statistics suggest that the US is on target for growth consistent with the IMF’s 2.3% forecast for the year. Several members of the Federal Reserve Open Market Committee or FOMC (whose voting members decide on monetary policy) have commented on economic trends and the outlook for monetary tightening in recent weeks: it seems that two more hikes in official interest rates and a gradual reduction of assets bought during the Quantitative Easing era (which in itself also put upward pressure on interest rates) are highly probable. As FOMC member Williams stated on CNBC (May 30): "It's not like we need fiscal policy in the short run to help the economy get back on track. We're actually in a good place in terms of where the economy is even without thinking about fiscal stimulus."
Earnings reports surprise
Reaching equity investment conclusions by “reading the tea leaves” provided by incoming macro-economic statistics can be useful in anticipating trends and adjusting portfolios. Corporate results are the reality check of the investment stances and the quarterly earnings reports season, in particular, offers the opportunity to assess a wide range of results. The earnings reporting season in May for the 2017 first quarter has been surprisingly positive and confirms a positive global growth momentum. According to Factset, for instance, companies included in the S&P500 index showed nearly 14% profit growth on a “blended” basis (combining reported numbers with estimates for those companies that have not reported yet). This compares with single digit earnings growth during the last quarter of 2016 and an estimated 10% advance expected ahead of the reporting period (according to Thomson Reuters).
It seems that the positive economic momentum is, to a large extent, the driver of corporate earnings surprises (the other main reason can be cost reductions). The adjustment of earnings forecasts to improving conditions implies that existing analysts’ estimates of Earnings Per Share (EPS) currently seem to be lagging behind the economic reality. Factset reports that in the S&P500 nine sectors have seen their projected growth rates adjusted upwards. It is encouraging to note that equity prices reacted positively to the results season on a broad basis, suggesting that the positive sentiment towards cyclical stocks immediately after the US presidential election is waning somewhat.
Earnings reports corroborated the investment strategies of the Dominion Global Trend Funds and the Funds’ investment portfolios continued to generate positive sales and earnings surprises. For the full year consensus sales projections (compiled from Bloomberg data) foresee 11% growth on average for the portfolio in the Luxury Fund, 10% for the Managed Fund and 13% for the Ecommerce Fund: these projections are more than twice the global (nominal) GDP growth rate of some 5% and indicate that the portfolios are well-positioned compared to cyclical sectors in the long run.
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