As trade uncertainties and tighter financial conditions continue to drag on economic growth, downgrades to consensus earnings growth expectations are picking up speed across major regions.
Three months ago, consensus analyst 2019 global EPS growth (earnings per share) was 10%, it is now at 7%, and we see the scope for further declines as we head into the earnings season.
Many of our clients have asked for our thoughts on this issue.
Exhibit 1: 3-month change in 2019E PS for major markets
Sources: Factset, MSCI, Bloomberg, Citi, Bank of Singapore
With the sharp market correction in 2H 2018, we believe it is likely that the markets have already moved ahead of analyst expectations in anticipating weaker earnings growth in 2019.
The market rally after the Christmas bottom reflected two new developments that have emerged since: 1) the "Powell Put", unveiled at the American Economic Association event on 4 Jan 2019, and 2) increasingly positive sound-bites from both the US and China on their trade talks.
History shows that EPS downgrades are not fatal for markets. Since 1989, there have been 15 years when global equity prices have appreciated while consensus analyst EPS forecasts have been downgraded.
Exhibit 2: Global equities YoY performance and annual changes to EPS forecasts
Sources: MSCI, IBES, Bloomberg, Citi, Bank of Singapore
In addition, earning downgrades are not unusual here: In the current cycle, in every year except 2017 and 2018, we have seen analysts moderating EPS expectations at this time of the year.
Looking ahead, the three major factors that will drive markets in 1H2019 are the direction of US-China relations (especially the outcome of current trade talks at end Feb 2019), the Fed’s hike path, and also the degree to which the global economy will slow.
On trade, in our view, it is conceivable that both superpowers can compromise sufficiently to forestall further tariff escalation – especially as President Trump now appreciates the effects of the tariff war on the US stock market.
Exhibit 3: Global EPS growth forecasts - moderation of EPS expectations is not unusual in the fourth and first quarters
Sources: Factsheet, MSCI, Bloomberg, Citi, Bank of Singapore
In terms of the global economic outlook, we expect a marked deceleration in 2019 but not a recession, particularly with the Fed on guard against downside risks, and inflationary pressures still relatively low.
At current valuations, we believe that equity market returns are skewed towards the upside, and we have a constructive stance on risk assets.
But the surprisingly swift deterioration in economic and market fundamentals in 2018 serves up an important lesson.
Fundamentals are becoming more transitory as we enter the late stages of the economic cycle, and investors need to be on high alert for fluid conditions ahead.
The tug-of-war between monetary normalization, slowing growth and gradually increasing inflationary pressures will continue to narrow the margin of error for central banks and policy makers.
This situation is exacerbated by widely-held expectations that the world is overdue for another downturn, as well as the reflexive dynamics between confidence levels, financial conditions and asset prices which tends to result in self-reinforcing cycles.
Higher volatility and risk premiums will also contribute to a challenging environment and lower investment returns ahead.
Disclaimer applicable to recommendation
In this environment, in terms of our asset allocation strategy, even as we maintain our core overweight positions for performance (overweight Asian equities and EM HY bonds), our key priorities are diversification of portfolio risk and downside management. We also have an overweight position in cash.
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