In the US and euro area a number of global bourses hit all-time highs in the first quarter. Europe led the pack, as sovereign quantitative easing (QE) was a catalyst to unlock value. Not only are euro area equities (particularly export and real estate related sectors) finally responding to a cheapened euro and zero interest rate policies (ZIRP), but a rising credit impulse has lifted relative performance out of a three-year funk. The European Central Bank (ECB) is distorting the yield curve just enough that capital should continue to rotate into equities. Global investors are voting with their feet as foreign purchases of euro area equities are booming.
We are bullish on growth in developed economies this year and next for several reasons:
- US banks have restructured since the crisis and are in a strong position to extend credit; indeed, the acceleration in broad money has been underpinned by faster expansion in private sector credit
- The ECB implemented a sizeable QE program, lowered interest rates, and helped depreciate the euro which should increase exports
- Similarly, Tokyo and Beijing are acting reasonably well to stimulate their economies
With US and German consumers now doing better – more employment, improving wages, and less income spent on gasoline – the outlook for export-led emerging markets has brightened.
Global growth will continue through 2015 and be more balanced and sustainable. A strengthening dollar is redistributing growth from the U.S. to Japan and the euro zone. The drubbing in oil prices has also contributed to the jump in consumer confidence and should continue to serve Europe and Japan well, owing to their energy importer status. A gradual global economic recovery will benefit export-oriented markets such as Germany, Japan, Sweden and select emerging market commodity importers that have considerable earnings leverage to stronger trade. The U.S. may remain a safe-haven in the near term; and in the euro area, risk/reward is favorably skewed by a combination of increasing policy reflation, depressed earnings and attractive valuations.
Liquidity conditions, driven by the ECB and the BoJ, will remain easy over the next year. Central Banks are in the driver’s seat. The end of the Fed’s QE program does not imply a tightening of liquidity conditions because the Fed will raise rates before it shrinks the balance sheet and simultaneously the ECB and BoJ could increase their balance sheets by $2 trillion. Policymakers around the world are “all in”, determined to keep liquidity conditions flush and protect the banking system.
In the US, banks have returned to health and credit to the private sector is expanding. Stocks can shrug off a slowdown in profits, especially if it is accompanied by a stronger economy and continued low long-term rates. Even if wages pick up, a consumer spending revival should counter a gradual squeeze on margins. So while the profit share of GDP may have peaked – the US economy will strengthen significantly in the second half of 2015 and remain robust in 2016 – the outlook for corporate earnings is reasonably solid and doesn’t imply a major equity correction. Although the overall level of spending in cyclically-sensitive sectors such as consumer durables, housing, and business capex is depressed by historic standards, the economy probably won’t run into serious trouble until monetary policy becomes restrictive with high real rates and/or the yield curve inverted. As long as economic growth is strong enough to keep earnings from contracting, but weak enough to sustain accommodative monetary policies, then the path of least resistance for the economy is up.
Michael Ashley Schulman, CFA
Hollencrest Capital Management