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Macroscope
OpinionComment
Patrik Schowitz
Patrik Schowitz

Macroscope | Will markets extend their record-breaking run into 2020? Watch what corporate profits tell us

  • Despite a recent surge, stock markets are roughly where they were before last year’s drop-off
  • Investors should watch what companies are saying about global conditions to anticipate what’s next

Reading Time:3 minutes
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After a sobering end to 2018, markets have revved up again, with the Nasdaq and S&P 500 rallying to record closing highs on April 23. Photo: AP
Patrik Schowitz

Records are there to be broken, as the saying goes, and not just among investors. Following the strong rally since the start of this year, global stock markets now seem to be in the process of breaking the record highs set in 2018.

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In the US, the benchmark S&P 500 index has just done so, while the benchmark MSCI All-Country World Index is now just a touch below its record high set in early 2018 after stripping out currency effects. Lagging somewhat behind, the Chinese CSI 300 benchmark index is now a little less than 10 per cent from its 2018 high, although admittedly that is still well below its previous highs in 2015 and 2007. While this is good news for equity investors, it also reminds us that stocks’ strong start to this year mostly represents just a recovery from the weakness of late last year.
How quickly markets can set records, and by how much, will mostly depend on the outlook for corporate profits. The main reason of the market sell-off last year was a realisation among investors that a serious slowdown in global growth was under way, even sparking fears of an impending recession. Those recession fears receded quickly, mostly thanks to the sudden stop in the US rate-hiking cycle and Chinese economic stimulus.
This has allowed markets to bounce back equally quickly, but with economic growth around the globe now looking distinctly mediocre, the downgrading of corporate profit expectations has continued to drag on. Global profit growth expectations for 2019 aggregated from analysts’ company-level forecasts peaked at around 10 per cent back in October and have been steadily dropping. Roughly six months later, they now stand between 4 and 5 per cent, roughly half their peak level.

Other regions have seen falls of similar magnitude, with US profits growth now expected at less than 4 per cent, while closer to home Asia-ex-Japan profit growth has dropped to 5 per cent.

This means that the strong equity market returns year-to-date are entirely due to rising price-to-earnings ratios. For instance, the 12-month forward P/E ratio on Asia-ex Japan stocks has risen to just over 13.5x today, from a low of less than 10x at the start of the year. Admittedly, this only takes valuations back to where they were in early 2018, but that was when the growth outlook was brighter than today, and it is appreciably above the long-run average of 12x.

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