MARKET UPDATE – JANUARY 2020
The aggressive change in sentiment and market positioning over the last 6-8 weeks of 2020 has been driven by a number of factors such as the immense provision of liquidity by the Federal Reserve, hopes that the trade truce will lead to a significant pick-up in global growth and earnings and the removal of the short-term risk of a no-deal Brexit. However, despite some pockets of strength in US data (employment for example), it is difficult to see a rebound in economic activity that would justify current market pricing. The announcement that Boeing would suspend production of its 737-MAX aircraft from January, for example, is alone expected to shave 0.8% from Q1 US GDP. Additionally, it seems inevitable that there was some front-running ahead of the possible increase in tariffs, which should dampen the expected rebound in growth in the short term.
If economic growth does not improve substantially, the consensus outlook for a rapid rebound in earnings, with growth of approximately 10% expected for 2020, looks too optimistic. Even if this growth in earnings is realised global equities look expensive, with a forward P/E of 16.4x. The US trades on 18.7x, Europe on 15.3x, Japan on 14.2x and China on 12.3x. These are close to the highs of the last decade. In absolute terms, earnings have declined this year, leaving the entire gain in equities in 2019 down to multiple expansion.
As noted above, one of the drivers of the most recent leg of the rally in equities was the provision of liquidity by the Federal Reserve. However, this liquidity splurge was designed to be short-lived, i.e. a year end liquidity provision. How markets react to the potential removal of much of this liquidity will be key – but if the extraordinary provision of liquidity continues, the valuation of high-quality companies can remain elevated relative to what might otherwise be considered fair value.