Quarterly Perspectives Europe 1Q 2018

Transcription

1 Quarterly Perspectives Europe 1Q 218 J.P. Morgan Asset Management is pleased to present the latest edition of Quarterly Perspectives. This piece explores key themes from our Guide to the Markets, providing timely economic and investment insights. THIS QUARTER S THEMES 1 Higher commodity prices: implications for the economy and markets 2 The myths and realities of the Chinese economy 3 Are equity valuations a reason to sell? 4 Eurozone: growth strengthening, risks diminishing STRATEGISTS Karen Ward Managing Director Chief Market Strategist for the UK and Europe Tilmann Galler, CFA Executive Director Global Market Strategist Vincent Juvyns Executive Director Global Market Strategist Maria Paola Toschi Executive Director Global Market Strategist Michael Bell, CFA Vice President Global Market Strategist Nandini Ramakrishnan Associate Global Market Strategist MARKET INSIGHTS Guide to the Markets Europe 1Q 218 As of 31 December 217 Jai Malhi Associate Market Analyst Ambrose Crofton Analyst Market Analyst

2 1 Higher commodity prices: implications for the economy and markets Why have commodity prices risen? 217 saw a relatively broad-based increase in major commodity prices. In dollar terms, the price of a barrel of brent crude oil was up 14%, while copper, aluminum and zinc all saw price gains of close to 3%. The primary reason for this was the expansion in global demand. All the major economies either met or surpassed the expectations for growth set at the start of the year. At the same time, some of the gain was due to expectations of lower supply as OPEC attempted to strengthen the commitment among its members to restrain production. Other assets Crude oil prices USD per barrel Commodities 217 change Change since 216 low Brent crude +17,5% +94,2% Share of total oil supply In % 212 1Q 217 2Q OPEC 42% 4% US 12% 2% Average: $5 31 Dec 217: $67 '92 '96 ' '4 '8 '12 '16 Crude Oil price and US rig count USD (LHS); number of rigs (RHS) 18 Oil price Metal prices Index level, rebased to 1 in Jan Aluminium GTM Europe 71 Rigs '7 '9 '11 '13 '15 '17 Copper Zinc Nickel '7 '9 '11 '13 '15 '17 OVERVIEW There was an uptick in many commodity prices over the course of 217; oil in dollar terms rose 14% this year. This largely reflects an improvement in the prospects for global demand. This will support the commodity producers and is one of the reasons we have become more optimistic about emerging economies in 218. With unemployment low in much of the developed world, it is possible that higher oil prices will encourage workers to request higher pay. Central banks assume that inflation will pick up only gradually. If wage growth were to pick up more swiftly, the central banks might feel under pressure to normalise policy more quickly. Stronger global demand has served to boost most commodity prices. Source: (Left) Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) Baker Hughes, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) Bloomberg, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 71 2 QUARTERLY PERSPECTIVES 1Q 218

3 A further tailwind for emerging economies Higher commodity prices will support the corporate and government revenues in those parts of the emerging world where mining and quarrying constitute a significant part of GDP such as Brazil, Chile, Indonesia and Russia. This is one of the many tailwinds that will support emerging economies this year. In addition, ongoing robust growth in China and stronger demand for capital goods in the West, will increase demand for the tech producers in emerging Asia. Growth became more globally synchronised in 217. If the recovery strengthens meaningfully in emerging markets, this could result in an even higher pace of global growth in 218. Assuming this does not coincide with much greater global inflation and thus tighter monetary conditions, then the backdrop is strong for global risk assets. EM aggregate: GDP and inflation GTM Europe 31 EM GDP growth EM inflation % change year on year % change year on year 1 12 Forecast Forecast Global economy Manufacturing countries Commodity countries -4 ' '2 '4 '6 '8 '1 '12 '14 '16 '18 Manufacturing 2 countries Commodity countries ' '2 '4 '6 '8 '1 '12 '14 '16 '18 Growth is recovering in the commodity producing parts of the emerging world. 31 Source: (All charts) IMF, national statistics agencies, J.P. Morgan Global Economic Research, J.P. Morgan Asset Management. Manufacturing countries are China, India, Malaysia, Mexico, Philippines, Poland, Romania, Thailand, Turkey, Vietnam. Commodity countries are Argentina, Brazil, Chile, Colombia, Indonesia, Kazakhstan, Peru, Russia, South Africa, Venezuela. GDP and inflation aggregates are calculated using the mid-weight average, which is the mean of GDP-weighted average and simple average. Forecasts are from J.P. Morgan Global Economic Research. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December 217. Source: Guide to the Markets Europe, page 31 J.P. MORGAN ASSET MANAGEMENT 3

4 Higher commodity prices could add to inflationary pressures One of the great conundrums of recent years has been the weakness of wages in the developed world, despite falling unemployment. Some have argued that households have accepted low wage growth because energy prices have been low so workers have not had much pressure on their real living standards. There is a risk therefore that higher energy prices might spur workers to bid for more pay. The central banks expect wage growth and broader inflationary pressures to recover only gradually. If we were to see wage growth pick up more strongly, we could see central banks under pressure to normalise monetary policy more swiftly. INVESTMENT IMPLICATIONS The combination of stronger growth in the emerging world and a weaker dollar will support returns on EM assets. It is possible higher commodity prices will add to broader inflationary pressures in 218 which could weigh on fixed income returns, particularly if central banks become more hawkish. US labour market GTM Europe 23 US unemployment rate and wage growth %, wage growth is year on year 12 Global economy 1 8 Unemployment 6 4 November 217: 4,1% It is possible that higher cost pressures embolden workers to ask for higher pay. 2 Wage growth November 217: 2,3% '67 '72 '77 '82 '87 '92 '97 '2 '7 '12 '17 Source: BEA, Thomson Reuters Datastream, J.P. Morgan Asset Management. Wage growth is average hourly earnings of total private production and nonsupervisory employees. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 23 4 QUARTERLY PERSPECTIVES 1Q 218

5 2 The myths and realities of the Chinese economy China is still at an early stage of development, with significant untapped potential China is often inappropriately analysed using the frameworks and experience of Western economies. The fixation with the Chinese residential property market is the most obvious of these. China has a low level of development: only 58% of the Chinese population lives in urban areas, compared to more than 8% in the US and UK. The construction boom must be seen through this lens. The Chinese authorities have made considerable progress in establishing the towns and cities that will form the foundations for future urbanisation and growth. Fewer than 1% of all Chinese households have a mortgage so fears of a Chinese property crash, leading to a 27 US-style crisis, are overblown. OVERVIEW Markets can be fickle, turning from pessimism to euphoria on a sixpence. But nowhere has the consensus lurched so wildly in recent years than on the forecast for China. These swings can be put down to two sources of confusion. The first is confusion about the inner workings of the Chinese economy itself and how it differs from that of the West. The second is confusion between the structural outlook for the Chinese economy and cyclical changes. Emerging markets structural dynamics GTM Europe 33 Global economy Urbanisation and economic growth Urbanisation rates, % and GDP per capita, USD, GDP per capita India China US South Korea Contribution to global real GDP growth % of overall growth 6 Global economic growth EM growth 5 DM growth As countries develop, increased urbanisation coincides with increased productivity and rising per capita incomes. Asian tigers, such as South Korea, witnessed similar rapid development in the 197s and 198s, but from a higher base Urbanisation rate -2 '9 '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18 Source: (Left) IMF, J.P. Morgan Asset Management. Urbanisation ratio refers to the proportion of the total population living within an urban area defined by national statistical offices. (Right) IMF World Economic Outlook October 217, J.P. Morgan Asset Management. 217 and 218 are forecasts from the IMF World Economic Outlook October 217. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 33 J.P. MORGAN ASSET MANAGEMENT 5

6 The structural outlook is robust, but overlaying that is a cycle The ability of the Chinese authorities to focus on meeting their long-term ambitions has been hindered by the tumultuous global cycle of the last decade. Many of the gyrations of the short-term, high-frequency data reflect these difficulties in trying to fine-tune policy and maintain a steady growth rate. With the onset of the financial crisis in 28, Chinese policymakers brought forward many of their development plans. China deployed a RMB 4 trillion fiscal stimulus package. This turned out to be a little too effective: nominal growth expanded at roughly 12% in 29, despite a huge contraction in exports. China spent much of the following three years trying to slow down activity, until the euro crisis forced it to expand stimulus again. Since then, China has been trying to fine-tune growth in the region of 6,5%, but this is challenging, even in a command system. Recently, the Chinese authorities have emphasised a focus on quality of growth over quantity. Growth may slow towards 6% in the coming year. China: GDP and inflation GTM Europe 29 Contribution to China real GDP growth Average China inflation % change year on year Q17 % change year on year 2 GDP growth 9,7% 6,8% 15 Investment Consumption Average since 26 November 217 Headline CPI* 2,7% 1,7% Core CPI 1,2% 2,3% Headline PPI** 1,1% 5,8% Global economy Net exports 1 5 China used investment to offset weakness in exports during the global recession in 28 and European downturn in '9 '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16-1 '6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 Source: (All charts) FactSet, National Bureau of Statistics of China, J.P. Morgan Asset Management. *CPI is the Consumer Price Index. Core CPI is defined as CPI excluding food and energy. **PPI is the Producer Price Index. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 29 6 QUARTERLY PERSPECTIVES 1Q 218

7 China is slowly transitioning to a consumer-led economy, which provides a host of opportunities for investors Volatility in exports and investment has driven the variation from trend growth in China. By contrast, consumer spending has remained relatively steady and robust. The Chinese household saving rate is currently nearly 4% of income. As household incomes rise and the country s financial and social systems develop, this need to save will likely ease. This will further support consumer demand, helping the economy move away from an industrial export-driven economy to a consumer-driven economy more akin to those in the developed world. Prior to the crisis, industrial production grew on average at around 15% as China increasingly served as the goods producer for the West. Industrial production has been relatively stable at about 6% in recent years. In contrast, retail spending continues to grow at double digits. Consumption was 36% of Chinese GDP in 27 and by 216, it had risen to 39%. This trend is likely to continue. INVESTMENT IMPLICATIONS As the Chinese economy continues to converge with its more developed peers, it will sustain growth that is well above that of Western advanced nations. As China turns from global producer to global consumer, it will help sustain robust global growth in the face of demographic headwinds in the West. The shift in growth towards consumption offers many opportunities for investors. Look to invest in companies that have exposure to this long-term story as demand for financial, health care, education and consumer products expands in China. China economic indicators GTM Europe 3 Global economy China credit growth % change year on year 6 RMB bank lending Augmented credit 2 1 Total social financing '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 China policy rate, interbank rate and reserve requirement ratio % rate 7 PBoC 1-year deposit rate RRR 25 China fixed asset investment (FAI) % change year on year '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 China industrial production and retail sales % change year on year 25 Public Overall Private Industrial production growth has settled at a much lower trend, but retail sales are still growing at double-digit rates. 5 SHIBOR Retail sales Industrial production 1 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 '96 ' '4 '8 '12 '16 Source: (Top left) People s Bank of China (PBoC), J.P. Morgan Asset Management. The augmented credit measure consists of all reported bank claims on the domestic economy, plus bankers acceptances, entrusted loans, trust loans, new net corporate bond and non-financial equity financing, issuance of asset-backed securities and interbank loans. Total social financing is a measure of total funds provided to the economy, tabulated from bank loans to individuals and corporations, as well as equity and bond financing to non-financial corporations. RMB bank lending is the sum of all bank-reported claims on domestic borrowers. (Bottom left) PBoC, Thomson Reuters Datastream, J.P. Morgan Asset Management. Average RRR for large and small banks. (Top right) FactSet, National Bureau of Statistics of China, J.P. Morgan Asset Management. (Bottom right) National Bureau of Statistics of China, Thomson Reuters Datastream, J.P. Morgan Asset Management. Industrial production is a three-month moving average and retail sales is a six-month moving average. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December 217. Source: Guide to the Markets Europe, page 3 J.P. MORGAN ASSET MANAGEMENT 7

8 3 Are equity valuations a reason to sell? Are equities getting expensive after another good year? Equity investors have enjoyed another good year. However, most equity markets still do not look expensive. In Europe and the UK, equity valuations are only in line with their long-run average and haven t become more expensive this year, as markets have risen in line with better earnings. In absolute terms Japanese equities trade broadly in line with UK and European valuations. EM equities have become more expensive over 217, despite very strong earnings growth. However, they are still only in line with their long-run average valuations. It is the US where valuations look somewhat expensive, albeit nowhere near the valuations that were seen during the dot-com bubble. Equities Relative equity earnings and valuations Global earnings NTM USD earnings per share estimates, rebased to 1 in Jan 29 US Japan EM Europe Global valuations Current and 25-year historical valuations Price-to-earnings 4x 75x 35x 3x 25x 2x 15x 1x 5x Current 31 Dec year range 25-year average GTM Europe Axis 37 5,2x 4,8x 4,4x 4,x 3,6x 3,2x 2,8x 2,4x 2,x 1,6x 1,2x,8x,4x Price-to-book OVERVIEW Despite the strong rally in equity markets over 217, valuations have not changed much since the start of 217 in Europe, the UK and Japan, as earnings have grown strongly. Only EM and the US have seen valuations creep higher as share prices rose by more than earnings expectations. With emerging market (EM) valuations starting from a low base, only US valuations look somewhat expensive compared with their long-run average. While US valuations certainly are not cheap, continued strong economic and earnings growth should help to support further gains for US equities, along with other less expensive equity markets. Equity valuations are not stretched outside of the US. x 4 US Europe UK Japan EM '9 '1 '11 '12 '13 '14 '15 '16 '17 '18 ex-uk Source: (Left) FTSE, IBES, MSCI, Standard & Poor s, Thomson Reuters Datastream, J.P. Morgan Asset Management. NTM is next twelve months. (Right) MSCI, Standard & Poor s, Thomson Reuters Datastream, J.P. Morgan Asset Management. Valuations refer to NTM aggregate P/E for Europe ex-uk, US, Japan, UK and P/B for emerging markets. Valuation and earnings charts use MSCI indices for all regions/countries, except for the US, which is the S&P 5. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December 217.,x 37 Source: Guide to the Markets Europe, page 37 8 QUARTERLY PERSPECTIVES 1Q 218

9 So is it time to sell US equities? US earnings expectations have risen, driving the stock market higher, but valuations have also expanded, partly in hope of an additional boost to earnings from tax cuts. The tax reform bill was passed in the closing days of 217 and analysts are still in the process of evaluating what the tax changes will mean for corporate earnings. Current US valuations caution that US equity returns over the next decade are likely to be significantly lower than those we have enjoyed since 29. We estimate returns will be only about 5% per year on average, compared with 19% per year since the start of this bull market. However, while starting valuations explain a significant part of long-term returns, they have not historically been a good predictor of returns over the next year. If US earnings expectations continue to grow, supported by positive economic growth, then US equities should continue to deliver positive returns in the near term. INVESTMENT IMPLICATIONS Expanding earnings should continue to support most equity markets. Only the US looks somewhat expensive. If US growth remains healthy, as expected, aided by tax cuts, US earnings should continue to grow and provide further support for US equities, even though valuations are above average. Valuations aren t a good guide to returns on a one-year horizon. Investors would be better off focusing on the outlook for the economy and for company earnings, both of which continue to look positive. US equities: Valuations GTM Europe 48 Equities S&P 5 earnings and performance Next 12 months earnings per share estimates (LHS); index level (RHS) S&P 5 EPS S&P 5 index level Forward P/E ratio x, multiple '9 '92 '94 '96 '98 ' '2 '4 '6 '8 '1 '12 '14 '16 '18 S&P 5 Shiller cyclically adjusted P/E x, adjusted using trailing 1-year average inflation-adjusted earnings 5 31 December 217: 32,4x Jul 1999: 24,5x Average: 15,8x Average: 16,8x 31 December 217: 18,5x Rising earnings expectations could continue to support US equities. 6 '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 6 ' '1 '2 '3 '4 '5 '6 '7 '8 '9 ' '1 Source: (Left) IBES, Standard & Poor s, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) IBES, Standard & Poor s, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Bottom right) Robert Shiller, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 48 J.P. MORGAN ASSET MANAGEMENT 9

10 4 Eurozone: growth strengthening, risks diminishing Eurozone recovery supported by consumption and investment The economic recovery has coincided with a significant fall in the eurozone unemployment rate. In October, the unemployment rate fell to 8,8%. This is the lowest reading since January 29, and is a significant improvement on the 12,1% rate at the peak of the crisis. The recovery of the labour market, combined with positive wealth effects from gains in the prices of financial assets and housing, has helped to increase consumer confidence. Low interest rates are also supporting consumer spending. The global recovery in world GDP growth, together with favourable financing conditions, is supporting business investment in the eurozone. This benign environment is reflected in rising PMIs across the board. The latest ECB staff projections suggest inflation will still be below the target of close to but below 2% for the next three years. Monetary conditions should stay accommodative for some time yet. The strength of economic indicators should support corporate earnings and, in turn, equity prices. OVERVIEW Many economies surprised to the upside in 217, but the eurozone was a star performer. In the third quarter, the annual rate of GDP growth accelerated to 2,6%. The manufacturing purchasing managers index (PMI) for the eurozone hit a new record high of 6,6 in December, which is consistent with the annual pace of growth remaining above 2,5%. Consumer spending has underpinned the recovery as strong gains in employment have pushed consumer confidence to a record high. The European Central Bank (ECB) remains concerned about low inflation and is likely to keep monetary conditions loose for some time. European equities: Macro correlations GTM Europe 39 Equities MSCI Europe and composite PMI Index level 65 MSCI Europe EU composite PMI 35 '99 '1 '3 '5 '7 '9 '11 '13 '15 ' MSCI Europe and consumer confidence Index level MSCI Europe European consumer confidence '99 '1 '3 '5 '7 '9 '11 '13 '15 ' Positive equity markets usually coincide with strong macro indicators. Source: (Left) Bloomberg, Markit, MSCI, Thomson Reuters Datastream, J.P. Morgan Asset Management. The composite Purchasing Managers Index (PMI) assesses the economic health of the manufacturing and services sector by surveying output and employment intentions. Dashed line at 5 indicates the level of the PMI where economic conditions are neither accelerating nor deteriorating. (Right) European Commission, MSCI, Thomson Reuters Datastream, J.P. Morgan Asset Management. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 39 1 QUARTERLY PERSPECTIVES 1Q 218

11 Political risks are receding, but Italian elections still loom ahead 217 demonstrated that economic recovery is a powerful antidote to populism. At the French and Dutch elections, voters turned to the mainstream parties in greater numbers than feared. There are still political events to overcome in 218, though they are unlikely to grab the headlines and challenge markets in quite the way that elections have in the last two years. The Italian election will take place in March, and the outcome is highly uncertain. The key risk stems from the ascent of the anti-establishment party Five-Star Movement (M5S). This party has previously argued for a referendum on euro membership, though this is not currently central to its election campaign. The most likely outcome is a weak coalition government. Although this is not ideal for the prospects of reform or structural change in Italy, sentiment in the wider eurozone is unlikely to be affected. After the breakdown of talks to form a so-called Jamaica coalition (a coalition among the Christian Democratic Union/Christian Social Union (CDU/CSU), Free Democratic Party (FDP) and the Green Party, named because the party colours are those of the Jamaican flag) in Germany, Angela Merkel (CDU) and Martin Schulz (Social Democratic Party, or SPD) are trying to revive the reigning grand coalition. A breakdown of the talks would leave the country politically paralysed until summer, delaying necessary EU reforms and pushing any fiscal stimulus further out into late 218. INVESTMENT IMPLICATIONS The valuation of European equities is still not stretched. Above-trend growth in Europe should be positive for the earnings momentum of European companies, giving the recent rally more room to run in 218. Alongside better prospects for growth, the risks of political upset are receding. The coming Italian election and a German political stalemate will be sources of uncertainty, but neither event is likely to trouble markets in the way of political events in 216 and 217. European politics GTM Europe 9 Europe economy Eurozone GDP levels Index level rebased to 1 at 1Q Germany Eurozone France Spain Italy Survey results: Do you support the euro? % answering yes as of November Nov 13 8 Nov 16 7 Nov Italy France Spain Germany Economic recovery in Europe is breeding support for the single currency Italian election polling %, monthly average 5 4 M5S PD FI LN FdI '7 '8 '9 '1 '11 '12 '13 '14 '15 '16 '17 '13 '14 '15 '16 '17 '18 Source: (Left) Eurostat, Thomson Reuters Datastream, J.P. Morgan Asset Management. (Top right) Eurobarometer survey, J.P. Morgan Asset Management. (Bottom right) Termometropolitico.it, Scenaripolitici.com, J.P. Morgan Asset Management. M5S is 5 Star Movement, PD is Democratic Party, FI is Forza Italia, LN is Lega Nord, Fdl is Brothers of Italy. Past performance is not a reliable indicator of current and future results. Guide to the Markets - Europe. Data as of 31 December Source: Guide to the Markets Europe, page 9 J.P. MORGAN ASSET MANAGEMENT 11

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