Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.
Theme 1: A mixed picture for global PMIs
The global PMI remained in expansion mode in July - this is a result of strong developed markets versus weak emerging markets. So, it’s not that much of a strong signal for global trade or commodities at the moment.
The July round of global PMIs showed a broadly mixed picture. The JP Morgan Global Manufacturing PMI was unchanged at 51. Essentially, it was a case of strength in developed economies being offset by weakness in emerging economies. The slump in global trade growth along with the crash in commodity prices is putting pressure on the emerging world, which is generally more sensitive to these factors in the short-term. You can see this in the way that the global PMI seem to have broken as an indicator for commodities and global trade. This is because it is largely being elevated by domestic strength in the major developed economies rather than a broader based expansion of the global economy. I’ve mentioned this divergence previously, and it remains a vulnerability for global growth.
Theme in pictures
Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream
Theme 2: US earnings momentum begins to recover
US earnings momentum rolled over across the board earlier this year, and has begun to recover. This has been led by the traditionally more defensive sectors.
In this case, when I refer to ‘earnings momentum’ it’s the composite indicator that uses the rate of change of forward earnings estimates (3 month rate of change of 12month forward earnings). This will increase if analysts are upgrading the outlook for earnings and decrease if the outlook for earnings deteriorates for the next 12 months. The other factor is the revisions ratio, which measures the degree to which analysts are upgrading versus downgrading earnings. This is a similar metric. I like to combine the two [using z-scores] as, by themselves, the indicators can be a bit noisy. You can think of this as partly a sentiment measure (analysts are people, and people are subject to bouts of enthusiasm and pessimism) and partly a fundamental measure (it will fall as the fundamentals deteriorate and may at times get carried away). It is inherently a mean-reverting indicator – i.e. rate of change aspect. Anyway, the point of this exercise is to look at the main sectors of the S&P 500 Index and see what the pattern has been as earnings have clearly deteriorated in the first half of the year. (This is because of the oil crash, strong US dollar, and weak China/ emerging markets). The key takeaway is that the deterioration in earnings momentum was broad based, and has broadly recovered – but the recovery is being led by the traditionally more defensive sectors.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, I/B/E/S
Theme 3: Something’s happened to investor sentiment since the Financial Crisis
The US bull market is the most ‘neutral’ bull market on record. Past examples say this could be bullish, but the absence of bearishness is a complicating factor.
One trend I previously highlighted is the increasing neutrality of investors in the investor sentiment surveys (with a focus on the Investors Intelligence [II] and the American Association of Individual Investors [AAII] in this analysis). As the market moves higher, investors have become more and more neutral. My suspicion is that there is an element of psychological scarring from the GFC as investors suspect the next GFC could come at any moment – a heightened sensitivity or aversion to bubbles. So investors resist being bullish, and in the context of a rising market where things are gradually improving they don’t want to be bearish either - so neutral is the place to be. So what? What happened in the past when investors were this neutral? Well, the problem is they have never been this neutral, so it’s hard to answer that question. We saw a rise in neutrality after the initial recovery from the GFC which was followed by a big bull market. We also saw a rise in neutrality in the middle stages of the dot-com bull market. And again in early 1990s before the late 90s bull market took-off. So you could make a case that it is a good thing. The complicating factor is the bears are also around the lowest point ever.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream
Theme 4: Monetary policy moves in emerging markets
Inflation has remained high in broad emerging markets, falling in Asia ex-Japan. As a result, monetary policy has, in aggregate, eased in Asia ex-Japan and tightened in emerging markets.
Some of you would have noticed that recently there were a number of monetary policy moves in emerging markets, with some central banks hiking rates (Brazil +50bps to 14.25%, South Africa +25bps to 6.0%) and others cutting rates (China -25bps to 4.85%, Korea -25bps to 1.50%, India -25bps to 7.25%, and even Russia reversing its panic hikes of last year, cut -50bps to 11.00%). We pay close attention to monetary policy because shifts in monetary policy stance can be either supportive or negative for equities/economies. So the below charts apply the lens of MSCI Emerging Market Equity Index and the MSCI Asia Ex-Japan Index to assess the respective monetary policy pictures. First point to note is the difference in inflation outcomes in Asia versus broad emerging markets. So, Asia has been given scope to cut rates while broader emerging markets have had to hike or hold rates in the face of still relatively high inflation. Asia made a clear transition to easing monetary policy, and will probably ease further. So the remaining question is probably “when will emerging markets cut rates?” Already Russia has turned the corner, and Brazil signalled a pause when it hiked another 50bps last week. The complicating factor will be when the US Federal Reserve starts hiking rates it will mean divergence in monetary policy, which will likely put their currencies under pressure…
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, Bloomberg
Theme 5: So what about emerging market currencies?
Emerging market currency weakness has been a long-running theme. It’s been accentuated by the US Dollar surge and commodity collapse. They are now ‘cheap’ – but it’s probably worth waiting a while longer.
Emerging market currencies have been in focus as they continue to grind down as investors bid up the US dollar in anticipation of the US Federal Reserve commencing a long awaited monetary policy tightening cycle. But emerging market currency weakness has been a persistent theme and reflects the slump in commodity prices following the boom of the 2000s. So a question you should ask would be “is it cheap yet?” Looking at the MSCI emerging market currency basket (which is relevant for investing in emerging market equities as you usually take on currency risk due to the cost/difficulty of hedging emerging market FX exposure), first point to note is it hasn’t fallen as much as the popular JP Morgan Emerging Market Currency Index. This is because China is a big weight and the CNY has traded in a tight range against the US Dollar. The second point to note is that it is undervalued against PPP (purchasing power parity – a longer term valuation measure for currencies). The emerging market currencies have, in aggregate, always been undervalued against PPP, but you can see that they’re slightly more undervalued than usual. They’re now undervalued to the same extent as they were in 2009, but nowhere near the lows of the early 2000s. So yes it is cheap, and equities are still sort of cheap too – so there is some valuation cushion. But the headwinds for emerging market currencies of weak commodity prices and the strengthening US Dollar would need to abate before a turnaround could be seen. There may be a case of buy the rumour and sell the fact when the Fed does eventually get around to hiking interest rates. And commodities as a whole have fallen quite a bit now, so we could be getting close, but it’s probably worth waiting… At the same time, risk pricing in emerging markets across equities and credit has gone into panic mode, which can be a sign that the trend is about to change.
Theme in pictures
Source: AMP Capital, Thomson/Reuters Datastream, Bloomberg, IMF
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