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  Some moderation

We share the concern, although in our view the worries were overdone. The equity market correction was an opportunity to buy into a market that we expect will trend higher for now. We do however not ignore the signals the markets are giving. Monetary policy in the US is being tightened and the effect of fiscal stimulus in the US is fading. We are more cautious with our overall cyclical outlook and no longer see the US economy as a clear positive for markets. Europe and Emerging markets have seen headwinds this year, but look stable.

To be clear, we are not sounding the alarm that a strong slowdown is imminent. The global economy, and the US in particular, continues to show strong growth and is moving well above trend. We do however see leading indicators softening and frictions in the economy increasing. The strong growth showed in the most recent earnings reported by companies. Earnings per share grew by over 25% in the US and were up 10% in Europe but it weren’t the hard numbers that rattled markets. It was the business outlook given by CEO’s for the upcoming year. Worries about trade, higher input costs and a tight labor market were often named as a reason why companies did not expect to keep growing their profits at the same pace. In the broader economy business confidence has also retraced from its highs reached earlier in the year, which translated to a decrease in corporate investment. With consumer confidence at cyclical highs and strong retail sales, consumers are doing a good job filling the gap left by corporates. They see their income rise and increase their spending, and have quite some room left to lever up. Thus while we expect a moderation, we do expect the economy to keep humming along at a solid pace. It is a reason for some moderation in our risk-attitude though. The negative market reaction to such a strong earnings season shows that there was a lot of optimism in the markets. With growth expected to decelerate the rich valuations for the US markets are likely to come down.

“The main concerns however, are political; Brexit and Italy are causing a headache for politicians and investors alike. ”

Europe’s economic growth has been sluggish for some time. Mainly because export growth from the continent came to a halt, which can be attributed to the strengthening of the euro last year. With that effect fading, there is less headwind for Europe. The main concerns however, are political; Brexit and Italy are causing a headache for politicians and investors alike. The Brexit negotiations are in a gridlock, the UK parliament is deeply divided and the solutions currently on the table appear dead in the water. At the time of writing* the cabinet of prime minister May appears to be falling apart, feeding further concerns and pressuring the UK markets. The Italian government is in a stand-off with Europe over their government budget, with neither side willing to budge. Italian spreads are pricing in significant risk but the market appears underwhelmed by the current developments. The back-and-forth between Italy and Europe can go on as long as the market is not putting pressure on Italy. Rates need to move higher from here before the Italian debt becomes unsustainable. In both cases some compromise will have to be found to calm markets, until they are made the stories are mainly a source of volatility rather than direction. Markets seem to have priced in quite some risk for Europe. Credit spreads have widened to their historical averages and equities have strongly derated from last year’s high.

Emerging markets have lagged this year for a number of reasons. A stronger dollar and higher interest rates put pressure on weaker countries, most notably the ones with a trade deficit or large amounts of dollar funded debt. Argentina and Turkey have been the clearest examples, but the rout was broader. Worries about global trade helped feed concerns about a slowdown in emerging markets. There was some relief though. China has announced new initiatives to stimulate its economy. The currency markets are stabilizing and risk spreads in US dollar denominated debt have narrowed. Brazil elected ‘tropical Trump’, a highly controversial but supposedly market friendly president. The outlook stabilized somewhat, but emerging markets face headwinds. Liquidity keeps tightening and global trade is under pressure. nonetheless given the discount in markets we expect the rout in EM to bottom out.

During last month’s broad sell-off one market stood out: the oil price dropped over 20%, moving well into bear market territory. Worries about slower growth translate to lower growth in demand for energy. At the same time the US is pumping up a record level of oil and was more lenient than expect about countries importing oil from Iran, which is under sanctions as of November. Together it made investors worried that the oil market will be oversupplied again. There are some signs the OPEC is willing to step in and stabilize the market at a higher level by cutting its output, but until they agree on a significant cut prices are unlikely to strongly recover.

Looking through last month’s noise we see solid fundamentals, especially in developed markets, but acknowledge that peak growth may behind us. Volatility is here to stay, but the worries are over done for now. Our outlook suggests there is no need to become outright cautious as an investor, and given the recent derating the outlook seems well reflected in the market. We stay cautiously risk-on but are slowly moving from ‘buy-the-dip’ to ‘sell-the-rally’.

 

Disclaimer
Kempen Capital Management N.V. (KCM) is licensed as a manager of various investment funds and to provide investment services and is subject to supervision by the Netherlands Authority for the Financial Markets. This information may not be construed as an offer and provides insufficient basis for an investment decision.

The Asset Allocation  Desk

Marius Bakker
Ivo Kuiper
Joost van Leenders

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