Vanishing Road

An Outlook - Beer Gardens and Grey Skies

Ben Kumar, Investment Manager

09 August 2018 - The way that global investors have been feeling about equity markets over the past few years should feel pretty familiar to the population of the UK as we go through one of the best summers in living memory i.e. “This is great, but it won’t last forever…”

However, while the sensations might be similar, the accompanying behaviours are quite different. Another day of sun and warmth is greeted with enthusiasm and excitement; people meet friends, wear sunglasses and flip-flops, and head to beer gardens. While in those beer gardens, conversation is usually about how nice the weather is, and how lucky we’ve been. Notably absent (at least in my experience), are suggestions to get inside and layer up NOW because at some point it will get cold again.

Yet, in the equity markets, that’s the prevailing mood. Every gain in the S&P 500 is greeted by a sort of gloomy acknowledgement of success, followed by a reminder that markets will fall eventually, and this sort of thing can’t go on forever. These views are often highlighted as part of a legacy of the Financial Crisis with investors remaining nervous and afraid. It’s as if one extremely cold winter ten years ago is still keeping us from fully enjoying the sun, and we descend into a panic every time it goes behind a cloud.

As we have been saying for some time now, there are a number of reasons to believe that we aren’t at the end of summer yet, in the equity market sense.

Our first reason is a familiar one. Companies are still making money – particularly in the United States. The results period for the second quarter of 2018 has lent unambiguous support for this view. Reported earnings in the US have been on average 25% higher than the same period in 2017. In addition, (and which is possibly more important), sales growth is nearly 10% higher than in 2017. This is significant, as the reported sales figure is less susceptible to artificial inflation from one-off events such as the tax cuts – it is largely just a reflection of how many units of product or service a company is managing to shift in any given period. So, bluntly, customers are buying more things, and we see similar strong sales figures around the rest of the world. Historically, that’s been a reasonably solid grounding for equity markets to continue to rise in the medium term.

“Expecting things to turn out well, and having them turn out picture-perfect is very good for confidence, and in the short term, equity markets need confidence.”

Our other reason is that these earnings and sales figures continue to surprise in a positive way, despite analysts doing their best to revise their estimates higher and play catch up. This is true across every sector in the US, whether tech, energy or consumer (unless of course Amazon has just taken aim at your business…). In fact, nearly 80% of businesses in the US have exceeded analysts’ forecasts this quarter. Really, this is close to an ideal situation – expecting things to turn out well, and having them turn out picture-perfect is very good for confidence, and in the short term, equity markets need confidence.

Of course, all good things eventually come to an end – we certainly aren’t suggesting that summer will last forever. Ultimately, expectations will go too far, and reality will fall too short. At the minute though, we seem to be some way off from the state of euphoria that prompts this kind of overshoot. What could change that? Another few earnings seasons such as this one, coupled with a disappearance of the worries about trade wars could be such a catalyst – although that seems somewhat unlikely at the moment.

An occasionally erratic grind higher for risk assets, propelled by fundamentals, in the face of geopolitical tensions is a reasonably good base case for the next few months. After that? We’ll have to assess the weather forecast, and see whether we should be preparing portfolios for an Indian summer, a gentle autumn or a long winter. The multi asset wardrobe should have enough clothes for any and all of these – in the meantime, enjoy the sun!

Ben Kumar
Investment Manager

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