Don't lose sight of the fundamentals

Deeper dive

Politics rather than economic fundamentals have been driving equity markets of late. February's equity correction was prompted by fears of higher inflation leading to faster rate hikes, but over the last month political risks have taken center stage. Concerns that the tit-for-tat trade dispute between the US and China may escalate and materially weaken global growth have weighed on stocks. More recently, the deteriorating geopolitical situation between the US and Russia over Syria has added to investor concerns. Further volatility related to trade and geopolitics is likely. But with the US first quarter earnings season now underway, the fundamentals should start to come back into focus and, in our view, are supportive for equities.

  1. Corporate earnings growth is robust. For full-year 2018 we expect earnings per share (EPS) growth of 16%, roughly half of which represents the boost from tax reform enacted in late December. For the first quarter, earnings growth is likely to reach 20%, the fastest pace since the end of 2010. Even without tax reform benefits, we estimate EPS growth will be a very healthy 12%. We expect revenue growth, which is not distorted by corporate tax changes, to grow by 7% in 1Q, one of the strongest growth rates in the last six years.
  2. The two largest sectors, tech and financials – accounting for more than 40% of earnings – both look poised to report growth of 20% or more. Most of the growth for tech reflects very positive enterprise spending trends and continued growth in secular drivers such as cloud and online advertising. Financials are one of the main beneficiaries of tax reform, but are also benefiting from higher interest rates, improving economic growth, and a pickup in trading revenues.
  3. Corporate earnings growth reflects strong economic momentum. US growth remains solid. Healthy business confidence and still-low financing costs are boosting business spending on investments and labor. In turn, this is boosting consumer confidence and driving consumer spending. The tax cut package only strengthens the near-term growth outlook. As a result, we forecast real US GDP growth of 2.8% in 2018 and 3.0% in 2019, the strongest two-year period since 2005–2006.
  4. US equity valuations have become more attractive during 2018 given the combination of sharply positive forwardlooking earnings revisions and flattish stock prices. The S&P 500 price/earnings ratio (on forward 12-month EPS) now stands at 16.4x – the lowest level in 18 months – and down from 18.3x at the beginning of the year.

Recent sources of market volatility may persist in the near term. We believe the best way to protect portfolios against these tail risks is to hold a diversified set of countercyclical positions and to hold downside protection through derivatives, rather than to exit equities. We expect inflation to be at the Fed's target this year and next, but the market may need more confidence that inflation is not accelerating beyond the central bank's expectations. Ultimately we expect solid economic growth and robust earnings trends to push stock prices higher. We remain overweight global equities, of which the US comprises about 50% of the global benchmark.

Mark Haefele

Global Chief Investment Officer WM

Bottom line

Politics, not economic fundamentals, have been driving equity markets over the last month. But with the US first quarter earnings season underway the fundamentals should come back into focus. US growth is solid and this economic momentum is supporting robust corporate earnings growth, which we expect to reach 20% in the first quarter. The trend in earnings has helped make US equities more attractively valued and we remain overweight global equities.



United Kingdom


Emerging Markets


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