2017 was characterised by powerful and synchronised global growth, whereas 2018 has been characterised by desynchronised growth, with US growth powering ahead, but many other areas experiencing slower growth. As we move towards 2019, with the US fiscal stimulus starting to wane, one of the questions dominating markets is what the growth environment will look like next year.
As we have mentioned previously, a growing set of economic data is consistent with a slowing environment, for example the global PMI survey has been indicating a slowing all year and US housing activity is slowing. However, what are markets anticipating? Well, we can look across asset classes, from equities and bonds to commodities, to glean some insight.
Starting off with equities, relative equity sector performance can be quite instructive. Defensive sectors such as utilities, pharmaceuticals and consumer staples, which tend to be characterised by more consistent corporate earnings growth, have outperformed cyclical sectors, which tend to be driven more by the economic cycle. The relative outperformance of defensives is consistent with markets anticipating a slowdown.
We can also look under the ‘equity bonnet’ by considering the corporate earnings revisions ratio, which measures the number of companies upgrading versus the number downgrading. The chart below shows that, with a number now less than one, more companies are downgrading than upgrading. This was evident across geographies and sectors, with the exception of energy. The ratio is now below the long term average and at a three year low. This suggests a deterioration in earnings expectations which would be consistent with a slowdown too.
Global corporate earnings revision ratio
Source: BAML, 31/01/1988 – 27/11/2018.
Turning to bonds, US Treasury yields have fallen of late (some of this is inflation expectations falling, in line with the oil price, and some of it has been real yields falling, i.e. growth expectations). Meanwhile, corporate bond spreads have continued to widen from the beginning of October, which is often an indicator of a slowing economy, though, again, energy sector spreads have widened more than other sectors, on the sharp fall in the oil price.
Turning to commodities, and the oil price itself, the significant recent fall seems to have been largely supply driven (geopolitics), rather than end-demand driven (economics). We say this as the major falls corresponded with specific periods where Trump pressured the Saudis to increase supply, plus when larger than expected waivers for US sanctions on Iran were announced, rather than a more gradual period of financial markets focusing on economies slowing. Meanwhile, other commodities, such as copper, are not showing material signs of slowing.
What does all this mean? Well, the falling oil price looks to have exaggerated the degree to which financial assets are anticipating a slowing. And, as outlined above, the oil price fall was not, in the main, a response to a weaker economic environment. Even so, many of the forward-looking indicators are moving in a manner consistent with growth slowing next year.
Assuming this is correct, it raises another set of questions. For example, is it likely to be a soft landing or a hard landing? Does the US central bank take its foot off the pedal? Can the Fed afford to, with wages pushing higher? What should sector positioning look like? At this stage, in terms of portfolio positioning, the above suggests retaining a defensive positioning, whilst awaiting more clarity.
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Past performance is not a guide to future performance.
Forecasts are not reliable indicators of future performance.
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Source for information: Miton as at 27/11/2018 unless otherwise stated.
The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment advice.
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