From Invesco: The global market backdrop remains challenged with geopolitics, trade, Brexit, rising oil prices and central bank balance sheet contraction all introducing incremental uncertainty to the calculus around earnings growth, interest rates and valuations.
For the time being, the equity market appears very much in de-risking mode, with a focus on earnings delivery and outlook statements as the third quarter earnings calendar gathers pace. Here are the issues that the Invesco International and Global Growth team is watching in the fourth quarter and beyond.
Is non-US earnings growth potential underappreciated?
The big question right now is to what extent strong growth in the US remains unique (even if it moderates as we roll through 2019). Strong US corporate cash flow looks well-supported by tax cuts and fiscal spending. In our view, this should underpin reasonably healthy capital expenditures and support economic growth and earnings delivery domestically — but will growth pick up abroad?
In the third quarter, select regions outside the US have seen a softening in gross domestic product expectations, industrial production and purchasing manager indices. There are many moving parts here: higher oil prices, higher US interest rates on dollar-denominated debt, weaker currencies, trade tensions undermining confidence, and more.
And yet, despite the soft patch in some of these macro indicators, there is a broad expectation that all major regions around the world (with exception of Japan) can potentially deliver high-single-digit to low-double-digit earnings growth in 2019.1 The region that stands out most is the eurozone, with consensus expectations for earnings growth to pick up from about 6% this year to 10% next year.2 On the other hand, expectations are for US growth to decelerate from more than 20% this year to about 10% next year.2
Higher interest rates represent a salient threat to valuations
Despite the stock market sell off in early October, we believe equity valuations for many of the market’s winners remain vulnerable to higher bond yields and discount rates, particularly among the technology names.
US stocks have continued to trade at a premium to non-US stocks, a fact which many have come to dismiss given relative earnings progression of the past several years.2 And yet, non-US market indices are now trading at discounts to the US on earnings and book multiples not seen in 15 years, with emerging markets discounts pushing to new extremes in the past two months.2 Three points to consider
- In our view, the high growth/high momentum reset is healthy. The October correction has so far inflicted the greatest damage to the share prices of high growth/high momentum areas of the market — particularly technology, where our team has chosen not to chase performance and high valuations. To the extent that some of these businesses continue to de-rate, we would expect to avoid much of the pain and potentially find some good long-term opportunities.
- The recent rise in the 10-year Treasury yield is positive in the near term, in our view, so long as inflation remains subdued.The rise in bond yields (discount rates to equity cash flows) has been driven primarily by higher real growth expectations from still low levels in the US. At the same time, weaker currencies relative to the dollar coupled with still negative real yields abroad remain stimulative to global growth.
- Trade and geopolitical tensions are the primary threats to the growth outlook.Ongoing trade/tariff disputes between US and China are problematic, as is the uncertainty that remains around Brexit, Turkish prospects and the disruption imparted by the new Italian government’s fiscal spending intentions, to name a few. China is the wildcard and is more difficult to handicap given the uncertainty associated with the Chinese leadership’s unwillingness to be seen as weak in the face of tweets from US President Donald Trump and aggressive tactics from his administration. At the same time, we should not dismiss the possibility of the US administration negotiating hard on the front-end with China, only to reach agreement in the final hour as was done with Canada and Mexico in the early-October USMCA trade deal.
To the extent that 1) central banks, led by the Federal Reserve, have moved past the point of maximum stimulus and proceed to slowly remove quantitative easing, and 2) bond yields trend higher, we would expect volatility to persist. In this environment, we believe our team’s high quality growth approach with an eye toward valuation should fare better after what has been a very difficult 24 months.
1 Source: FactSet Estimates, as of Oct. 15, 2018
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Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The S&P 500® Index is an unmanaged index considered representative of the US stock market.
The MSCI EAFE Index is an unmanaged index designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.
Matthew Dennis, CFA
Senior Portfolio Manager
Matthew Dennis is a Senior Portfolio Manager with the Invesco International and Global Growth team, focusing on large- and mid-cap equities in Europe, Canada, the Middle East and Africa. Mr. Dennis is the lead portfolio manager on the Invesco Global Growth strategy and a co-manager of the Invesco International Growth and Invesco European Growth strategies.
Mr. Dennis joined Invesco in 2000 as a senior equities analyst on the International and Global Growth team and was promoted to portfolio manager in 2003. He assumed his current role in 2011. Prior to joining Invesco, he spent six years as a London-based equity strategist. Mr. Dennis served as a European and global equity strategist with ABN AMRO from 1996 to 2000. He began his investment management career in 1994 as an analyst on the equity strategy desk at Hoare Govett Securities.
A native of Houston, Texas, Mr. Dennis earned a BA degree in economics from The University of Texas at Austin and an MS degree in finance from Texas A&M University. He is a CFA charterholder.
The Invesco QQQ (QQQ) fell $6.31 (-3.69%) in premarket trading Friday. Year-to-date, QQQ has gained 10.00%, versus a 1.61% rise in the benchmark S&P 500 index during the same period.
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