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This year has been all about America. And why not? It’s been quite the show. Trump’s rants from the Twitter pulpit (averaging 12 tweets per day). His infidelity to the post-war system. A nail-biting mid-term election. But most glaringly, a stock market – contrary to its struggling global peers – soaring on government wings. Underpinning this recent levitation is a robust 20% plus third quarter year-over-year earnings-per-share growth rate and a record high for operating profit margins (11.5% at latest reading). But has gravity begun to tug at this vertiginous liftoff?
Worries about slowing growth abruptly hacked off 7% from the MSCI US Equity Index in October. More ominously, a growing consensus views corporate earnings as already at their high for this cycle. Peak profits may have arrived.
We are not so sure. Yes, earnings growth will slow materially next year. One cannot overlook the primary drivers in 2018: corporate tax cuts and the rapidly widening U.S. government budget deficit. Crucially, these have one-time impacts. From here, earnings growth rates will come down. Investors who extrapolated this year’s lofty numbers will have to adjust their narratives. And the U.S. stock market may struggle. But the absolute level of earnings is unlikely to peak until the macro data confirm a significant economic slowdown. We are not there yet.
Taking a wider world view of corporate profits, expectations for global ex-U.S. earnings growth are downright sour. China is viewed as a victim of U.S. trade brinksmanship and a rapidly slowing economy. Emerging markets are seen as vulnerable to a virulent contagion replay of 1998. And Europe has been left for dead.
What could go right here? Actually, quite a lot. Regularly, our investment team peers into the BAML Global Fund Manager Survey,* a kind of investor voyeurism, giving us statistical snapshots of our competitor’s positioning (hey, even professionals can provide contrarian signals). November’s report shows widespread gloom. Most fund managers expect global profits to deteriorate over the next 12 months, their most bearish view in six years. Negative profit expectations also marked equity lows in 2011 and 2016.
Similarly, economic expectations have collapsed: 44% expect global growth to decelerate in 2019. This is the most negative reading since the depths of the 2008 global financial crisis and also more depressed than equity lows in 2011 and 2016. In other words, there is plenty of room for positive earnings surprises outside the U.S.
Meanwhile, no one is talking about it, but emerging markets have been firm in recent months and are likely forming a solid base. Even in China, where the market is expecting an outright profit contraction, policy reflation is gaining momentum. Lower interest rates, a cheaper renminbi and easier access to credit argue for higher corporate profitability. Stock prices should begin to reflect the improvement in the earnings outlook in advance.
We reiterate our call to rotate away from the U.S. into global exposures. Deeply depressed sentiment, reasonable valuations, and early signs of corporate profit improvement in many global regions make this an asset allocator’s dream setup. Don’t miss it!
* Hat tip to Urban Carmel for providing this data: https://www.fat-pitch.blogspot.com
Tyler Mordy, CFA, is President and CIO for Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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