Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, John Bilton, Global Head of Multi-Asset Strategy, J.P. Morgan, outlines four investment themes that will set the post-summer holidays agenda for markets.
Newsflow this August appears dominated by China. But for all the prevailing attention, it is not the only issue investors and asset allocators are grappling with; there are four themes which they should watch, and these will set the agenda for markets in the coming weeks.
Weak oil is not helpful for S&P earnings
First, the timing of the US Federal Reserve’s rise in interest rates continues to hold investors’ attention. We sit in the September camp, on the grounds that the job and housing markets support a move sooner rather than later, even if inflation continues to lag.
Ahead of the hike, markets are following a classic playbook – uncertainty and modest derisking in stocks, and mild flattening in yield curves. Performance of the S&P500 and the U.S. yield curve are broadly in line with the average of the run-up to the last five rate hiking cycles.
There are, of course, many warnings that equities will struggle when rates start rising, and in the short run history bears this out. In the three months following the start of a hiking cycle the S&P tends to dip by, on average, around 5%; but subsequently stocks tend to regain their poise and returns outstrip bonds for the remainder of the hiking cycle.
Second, a softening China has important global implications. China is in the painful process of changing how it achieves growth, aiming for consumption and productivity rather than exports and capital expenditure. Market liberalisation efforts, such as moves towards floating the currency, are fundamental to this process. Although there is real and concerning weakness in China, the notion that the drop in the value of the Renminbi was the opening salvo in a currency war are likely wide of the mark.
Far more profound is China’s reduced demand for commodities, a secular issue that will weigh meaningfully on emerging markets for some time. China plays a central role in driving demand for major commodities, and lower demand means lower commodity prices, in turn keeping a lid on global inflation. The ramifications of this go well beyond emerging markets and traditional commodity producers as the structural decline in commodity prices will likely affect global inflation for a meaningful part of many policy makers’ forecast horizons.
Third, the European recovery and the fluctuating relevance of Greece remain key themes. It is noteworthy just how isolated the recent weakness in the Greek economy is from the broader Eurozone.
We should not play down the hard road that Greece has ahead in repairing their economy, but Greece itself now has little bearing on Europe’s broader economy – Greece was always a small component of Eurozone GDP, but now the fragilities via the banking system are dramatically smaller than back in 2010-12. As a result the most recent Greek crisis is likely to manifest itself as a temporary blip in Eurozone wide confidence survey data, and little more. We note that despite the recent volatility European equity earnings growth is now outstripping US in earnings growth for the first time in five years, albeit from a much lower base.
Fourth, the double dip in oil prices. Massive inventory growth in the US at the beginning of the year and global oversupply has put pressure on oil prices, and as the U.S. “driving season” comes to an end the inventory overhang is again dictating the oil price.
Of course, weak oil – especially in combination with a strong dollar – is not helpful for S&P earnings. If we account for the effect of oil and the dollar earnings will be a scratch this year in the U.S.; the bad news is we’ve foregone a year of earnings growth, but the good news is that we know why, and it’s unlikely to repeat in 2016.
If we strip out energy, earnings on the S&P this year are growing at closer to 10%. Top lines are more concerning – that is certainly true – but as household incomes start to rise, and the benefit of cheaper fuel and gasoline beds down in consumers’ minds, we expect further support. There’s no denying it’s been a frustrating year for U.S. equity bulls, but there are certainly reasons to be positive.
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