In this update we explore five themes of relevance to investors.

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: Diverging growth prospects

A divergence has opened up between a relatively strong consumer and services sector against the backdrop of a softening business and manufacturing sector – this divergence will close, but the way that it closes will be very important for the global growth outlook.

We have been talking about diverging growth prospects between economies and regions for some time. Another of the key divergences is the gap between business confidence and consumer confidence. There’s also an emerging gap between the services and manufacturing sectors, as reflected in the Purchasing Managers’ Index (PMI) surveys, both in terms of level and rate of change. I’m still of the view that this can be explained by the commodities and currencies effect. That is, crashing commodities impact the business and manufacturing sector straight away, while providing the consumer a confidence boost as cheaper energy costs means more dollars in the pocket. With economic charts like these, the gap will ultimately close (as one sector is either pulled up by strength or dragged down by weakness). My view is that the consumer and services strength is sustainable given improving labour markets, cheap borrowing costs, and the oil boost. To that end, I believe the gap will eventually close when manufacturing and business performance catches up – but I remain open-minded and will closely monitor the situation for signs of weakness.

Theme in pictures

Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream

Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream

Theme 2: Consumer confidence and the misery index

Don’t lose faith in global growth while the major developed economies have a strong consumer sector and positive domestic stories.

The ‘Misery Index’ is a bit of a gimmick indicator, but interestingly it captures the key trends in the major developed economies at present, reflecting the unemployment rate and inflation. On the unemployment front, it indicates that labour markets are improving across US, Japan, and Europe (in that order). On the other hand, inflation is being suppressed by the energy price slump – which is good for consumers. The Index serves to highlight the fact that we’re currently seeing higher real incomes (through cheaper petrol) and stronger jobs markets (more jobs and higher wages) in developed nations. This is a key reason for not getting too bearish on the global economy. Despite the apparent and real weakness in emerging markets, it appears that fundamentally the major developed markets are domestically stable.

Theme in pictures

Source: AMP Capital, Bloomberg, Thomson/Reuters Datastream

Theme 3: Constrained US sharemarket returns

Expect returns to remain low in the US. Improved performance is dependent on sales growth and higher valuations, and there is uncertainty around both of those.

With returns on US shares deteriorating, it's timely to investigate the three key drivers of S&P 500 performance: dividend yield, earnings growth, and change in valuation. Expected returns are still pretty low, having risen only slightly during the recent correction via the expected change in valuation component. Looking at the drivers of historical returns, earnings seem to have become the dominant driver again. The contribution from earnings has also fallen, with sales growth under pressure (about 1% year-on-year versus the long-term average of 4%) with profit margins still doing most of the heavy lifting. The recent softness in sales earnings growth is largely driven by oil (energy sector) and the strong US dollar (exporters and companies with large offshore operations). In this context, where will S&P 500 returns come from? The dividend yield is about 2% and valuations are around fair value and close to their long-term average. If we assume no change in profit margins and a reversion to average sales growth of 4%, that should provide earnings growth of 4% and an expected return of around 6%, which is fairly uninspiring. To see higher returns from the US, we would need to see more enthusiasm on the valuation front or a more supportive sales growth environment. There is uncertainty around both of these things, but if the US consumer is up to the task, it may help US corporates deliver on the sales front.

Source: AMP Capital, Bloomberg

Theme 4: European equities still look good

While uncertainties remain, we remain bullish on European equities following the correction.

Around the start of this year there was a lot of excitement about European equities as the European Central Bank (ECB) forged ahead with quantitative easing. Recently, global market panic has seen an enormous sell-off. In this context, my view on Europe has not changed as it still has:

What has changed? It's gotten a little cheaper and maybe the external environment is less certain, but not enough to outweigh the previous points. The softer growth in China is a concern for countries like Germany that are major exporters, but overall I believe concerns about China’s impending collapse are overdone. Therefore, unless something material changes, there is a strong case for staying invested in European equities.

Theme in pictures

Theme 5: China property market continues to rebound against structural headwinds

China’s property market is rebounding against structural headwinds. Further monetary easing should help sustain the rebound – this is a positive thing for the cyclical outlook in China.

For China, like most economies, the property market is a key driver of the business cycle and in turn the risk and credit cycle. It is encouraging then that there is a clear upturn underway in the Chinese property market. Further targeted easing measures (reduced deposits for second home buyers through the provident fund and easing for foreign purchases) coupled with previous targeted easing measures (changes to mortgage rules, lower mortgage lending rates, wind-back of purchase restrictions) has helped trigger off a rebound in property prices from the sharp downturn that we saw last year. This has been supported by a very gradual clearing of inventories, most notably in the big cities and a string of other monetary policy easing measures (interest rate was cut five times by 1.4% in total and the RRR was cut four times by 2% in total). Sales have also begun to pickup, which is helping clear the high levels of inventories from the overbuilding that went on and this may set things up for a muted pickup in development. Aside from reducing the headwinds from the slumping property sector which includes property development and related industries, improving property prices have had a clear positive impact on consumer confidence. Therefore, once again, it’s hard to become too bearish on China when the property market is clearly improving.

Theme in pictures

Source: AMP Capital, China Index Academy

 
About the Author

Callum Thomas, MMgt (finance), MMgt (banking), BBS (finance), Investment Strategist

Callum is an Investment Strategist in the strategy team of the Multi Asset Group at AMP Capital. Callum has a passion for global macro investment strategy and constantly strives to generate unique and innovative insights that help inform the strategy team's dynamic asset allocation process. Callum is responsible for researching a range of asset classes and global macroeconomic themes to aid in formulating investment strategies across the Multi-Asset Group. He also keenly collaborates with the global equity and fixed income teams. Callum originally joined AMP Capital in June 2009 as an analyst in the investment business of what was then AXA New Zealand. He previously worked in strategy at the New Zealand Stock Exchange.