The UK’s Sky News has launched a “Brexit Free” channel, specifically excluding news items related to the UK’s departure from the EU. But while UK viewers have the luxury of switching channels at any time, investors often feel compelled to watch whatever is moving the markets day to day.
Will a resolution of trade tensions and a Brexit deal allow investors to switch their focus from geopolitics to fundamentals? And if they do, will they find a thriller or a horror show? We look at the key factors in shaping our outlook:
President Trump now appears more willing to consider a partial deal, focused on the US postponing tariff increases in exchange for China purchasing more agricultural products. Additionally, China may be prepared to agree to an interim deal, provided it is based on “mutual respect.” But we believe it is still too early to say whether the trade drama will subside: No US-China deal has yet been signed, Europe has threatened retaliation for recent US tariffs, and US congressional discussions regarding Hong Kong threaten to complicate the picture.
Beneath the geopolitical noise in recent months, the market has generally developed a consensus of “manufacturing and investment bad; consumer and employment good.” We think there may be cause for cautious optimism in recent investment data. While we are doubtful that businesses are going to embark on a spending spree even if there is an interim US-China trade deal, there are early signs of stabilization in capital expenditure. But this better news on manufacturing and investment has been accompanied by softness in consumer data with US retail sales unexpectedly dropping in September.
We do not think US earnings will disappoint in 3Q. Although we forecast just 5% earnings per share (EPS) growth in the US next year versus consensus of 10%, this gap is close to normal given the trend for bottom-up estimates to be revised down over the course of a year. But we think analysts may be too optimistic on EM and Eurozone earnings. The gap between our estimates and consensus is widest in the Eurozone, where we expect a further contraction in EPS of 3% in 2020, compared with consensus forecasts for 11% growth. In emerging markets, our estimate is for 6.5% EPS growth next year against a consensus of 14.1%.
If investors turn their attention further from trade they are also likely to consider the prospects for policy stimulus. In our view, the policy outlook remains supportive of continued sluggish expansion. We remain confident that central bank actions will continue to limit the risk of a US or global recession and the chances of a major selloff in risk assets. While there are some grounds for optimism on fiscal policy stimulus, in our view there is little hope for meaningful policy expansion unless the economy deteriorates.
On balance we continue to focus on earning yield rather than looking for higher equity prices. It is certainly possible that equities finally break out of their last six months’ trading range, for example in the event of a positive surprise on US-China trade such as an indefinite suspension of the December tariff increase, or a better-than-expected recovery in manufacturing. However, after a strong year for balanced portfolios, we think it is prudent to be more critical about the current valuation, growth, and geopolitical outlook.
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