Risky assets enjoyed a sharp reversal in October, with the S&P 500 turning in positive territory (+2%) after an intra-month loss of 4%. The index is now hovering around new all-time high, thanks to an abating escalation in trade war between the US and China and as fear of a no-deal Brexit dissipated. Moreover, market participants have been keen to endorse the rosy scenario of a stabilisation in some macro indicators and a brighter economic outlook for 2020, thanks to the new round of monetary policy easing around the world. Indeed, the Fed cut interest rates for the third consecutive time, while the ECB is relaunching a quantitative programme. On top of that, and according to some analysts, (Merrill Lynch), there have been 54 global interest rate cuts in 2019. Whilst we acknowledge that such accommodative moves by central banks is a game changer for avoiding a global recession in the next six-nine months, there are some valid arguments calling for diminishing effectiveness of monetary policy in the developed world, notably in the countries where negative rates are already in place.
The current European economic landscape might actually be a good illustration of this situation. Indeed, despite the very supportive interest rate environment (10-year yield of the German Bund were in negative territory since April 2019), the European Commission in early November cut its 2019 growth forecasts for the Eurozone to their lowest levels since the sovereign debt crisis, from 1.2% to 1.1%. In Germany, the country is on the edge of a mild technical recession after the publication of the first estimate of the Q3 GDP growth. For 2020, the institution also cut its 2020 growth projection to 1.2%, from 1.4%. It appears dovish monetary policy in Europe is slowly reaching its limit in terms of economic impact. At least, however, the ECB has been able to avoid the worst, as recent macro data are displaying a shy stabilisation. Some leading indicators such as the ZEW survey in Germany are strongly recovering, while the PMIs finally bottomed out.
Is this economic stabilisation enough to justify an addition to the equity exposure? We do not believe so, for several reasons. We are witnessing a sharp earnings slowdown in 2019 (close to 0% EPS growth for the Stoxx 600 and the S&P 500), which means that 100% of the current market price appreciation is based on a multiple expansion. For 2020, EPS growth expectations are high, at a rate of around 8-9% according to the Factset consensus, meaning there is a high risk of disappointment. Last but not least, based on the historical relationship between P/E forward valuation and PMI composite (exhibit 1), investors are already discounting a sharp recovery in the leading survey number (above 55) for the coming months, leaving only little room for further multiple expansion, which will likely cap the upside potential on equities. Therefore, we prefer to be mildly underweight on equities, waiting for better entry points.