Upbeat outlook maintained

By Noel O'Halloran (CIO), Monday, 8th July 2013 | 0 comments

picture 18Upbeat outlook maintained

Despite the recent volatility of markets, I remain confident on the outlook for equity markets from here.  Unless there is a significant policy mistake by a major government or central bank (which is unlikely), the macro environment will remain positive while valuations are also attractive.  We are not making significant changes to our positioning or forecasts.

Q2 Review

Before looking in more detail at the outlook, however, it’s worth taking a quick look at the outturn for the second quarter.  Equity markets were little changed, though the dispersion of returns across both equity and bond markets varied considerably.  The MSCI World equity index lost 0.6% in euro terms on the quarter and returned a positive 10% for the first half of 2013.  In euro terms, Japan was the strongest market returning +3.1% in response to strong stimulus policies from the central bank and government.  Emerging markets were weakest, falling by 9.2%.  In other asset classes, commodities fell by about 6% in euro terms as measured by the GSCI index, while Eurozone bond markets showed modest losses as yields rose in reaction to the comments in relation to “tapering” of monetary policy by the US central bank.


The current bull market commenced in March 2009 with the bull market consistently underpinned by two important tailwinds that I have consistently highlighted:
• Global central banks providing liquidity support and in so doing using various stimulus tools and extraordinary support measures along the way
• Improving macro fundamentals.  Both the global economy and corporate earnings have continued to slowly but steadily recover over this period.

Despite the change of mood in markets during the month of June in particular, I don’t see this as the commencement of a renewed equity bear market.  Nor is it a reason to make radical changes to our forecasts or portfolio positioning for clients.  I remain positive on the outlook for equity markets from here.

To materially change our positioning we would need to forecast a material change in the direction of tailwinds listed above or we would have to forecast a policy mistake by either a major government in relation to its macro policies (e.g. China) or a major central bank (e.g. the Fed).  While we do expect that the Fed will commence its tapering operation in September, this will only be the case if the economic fundamentals warrant it.  Such a classic handover of the baton from liquidity to fundamentals should not be a major negative for equity markets in that it is supportive of earnings growth while it remains less positive for bond markets.  It is also worth noting that the Fed will still be loosening policy (just at a slower pace) and at the same time all other major central banks maintain extremely loose monetary policies.

Bonds: selling off at last

For bond markets I (like many others) was in danger of being the “boy who cried wolf” for a number of quarters by calling the end of the bond bubble, BUT there is a significant chance that the 20 year bond bull market has come to an end and that the modest back up in yields seen during the recent quarter is the beginning of the end.  An environment of less liquidity support and stronger fundamentals is certainly more supportive of equities than of bonds.

Macro data from the US economy (payrolls, consumer confidence, and ISM indices) and also Europe (ISM indices, industrial production data) has in aggregate surprised positively.  Data from emerging economies and China in particular has on the other hand generally been on the negative side of expectations but not by any major magnitude.  We expect the US economy to be stronger again from Q3 onwards, Europe to emerge from recession by Q4 2013 and no hard landing in China.  This means that the macro environment will be a positive fundamental support for equity markets.

Summer headlines

Over the summer months a number of factors are likely to be in the headlines and will affect markets:
• US economic data will be monitored and interpreted for what it means for Fed policy
• Economic data in emerging economies and China in particular will be watched closely.  Evidence that economies such as China are not heading towards a hard landing will be particularly positive for emerging market equities, and for commodities.
• Geopolitical developments will remain important, in countries such as Brazil, Turkey and Syria
• The company earnings reporting season will be important not just for the reported earnings but also the outlook commentary by management teams around the world

Valuations supportive

At an asset class level, valuations of equities remain supportive and are at the cheap side of fair value.  For example, the valuation of emerging market equities - after the recent selloff - is particularly attractive, with a P/E ratio close to 10x.  I do not expect that a continued rise in bond yields will undermine equity markets.  To be fair the opposite didn’t happen to equity markets as bond yields dropped over recent years!


In summary, despite recent “noise” I remain positive on the outlook for equity markets and negative on the outlook for bond markets from here to the end of the year.  The summer months may see equity markets generally treading water until more macro clarity is evident from both the developed and emerging economies in particular.  However, I do expect that the environment will remain supportive and that the main tailwinds will be maintained as a strong further prop to equity markets.  I maintain my conviction that factors such as cash flow, quality, dividend and earnings growth will be winning factors from a stock picking perspective.

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