Weekly view - Back to basics
In the main, stock markets continue to look through a rise in global virus infections to brighter days ahead. There are indeed grounds for optimism as economic data improves. But we also think the Q2 earnings season should be a time when markets go back to basics. The fact remains that we have very little visibility. Only 49 of S&P 500 companies have provided earnings guidance, well below average, while consensus estimates are that earnings per share will be almost 45% lower in 2Q than a year earlier—yet the 12-month forward price-earnings ratio is well above the five-year average. In short, we need companies to provide firmer guidance about the road ahead to sustain a broad market rebound—all the more so as stock buybacks have dried up and dividends are much lower than before.
Stock market optimism is nowhere more evident than in China, with the MSCI China rising a hefty 7.5% last week. We have been here before; encouraged by state media, retail investors piled into stocks in 2014-2015, often borrowing to do. But the bull market quickly turned into a bear when the authorities moved to stamp out margin trading. Yet we think the fundamentals are better this time. For a start, China has a head start when it comes to recovery (we expect real GDP growth of 1.2% this year). In addition, borrowed money in the stock market is well below 2015’s peak—and the People’s Bank of China is already withdrawing liquidity from the financial system to limit speculation. Furthermore, Chinese valuations remain reasonable when compared to their western peers’. We therefore remain upbeat on China, seeing it as the best option for emerging-market investments.
This week will see a European Council summit debate details of a recovery fund, with the so-called ‘frugal four’ still holding out against the notion of grants for southern Europe. We remain optimistic that agreement will be found at the summit or in the coming weeks, and that the EU will achieve greater fiscal cohesion in the process. Compromise will be needed and important strings will be attached to any ‘grants’, but with France and Germany behind the proposal to issue common debt, euro assets are steadily becoming investible again.