Many central banks are expected to begin easing monetary policy this year, which could provide support for global markets. From a broader view, however, strong earnings growth will likely be required to support equity valuations while persistent inflation, elevated interest rates, political uncertainty in the U.S., geopolitical risks and recessions in some developed economies may serve as headwinds for asset prices.
Summary – IBKR Podcasts Ep. 138
The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.
Jose Torres
Hello everyone and welcome to Interactive Brokers IBKR podcast. I’m Jose Torres, your senior economist and I’m joined today by the Chief Global Investment Strategist at Ned Davis Research, Tim Hayes. Welcome, Tim.
Tim Hayes
Thank you.
Jose Torres
Our pleasure. So, let’s get straight into it with a global growth question. The World Bank predicts that global growth is projected to slow from 2.6% last year to 2.4% this year. How has that influenced your outlook for equities and bonds? Does developed or emerging markets outperform?
Tim Hayes
I think it will be a positive environment for both stocks and bonds in that the slowdown is enabling the central banks to cut rates and provide liquidity. Really the question is more about the timing of that rather than whether it will happen. You must have enough of a slowdown to support that development and bonds will benefit as yields decrease, but equity will outperform bonds as they rally. This is evident in our recommended allocation, which is 70% stocks, 30% bonds and 0% cash. That’s based on a benchmark allocation of 55 stocks, 35% bonds, and 10% cash. On the question of developed versus emerging, we are overweight the US we’ve been overweight the US. Which is about 64% of global market cap. We’ve been overweight since July and developed markets in general would outperform emerging markets inclusive of China, but if you exclude China, several emerging markets have been doing well and should continue to do so such as India. They would be more likely to perform in line with the developed markets. In fact, if you look at China at EMX, China, it’s been pretty much a market performer similar to developed markets.
Jose Torres
Interesting, and a key feature most of the developed markets are near all-time highs and China has been doing particularly bad from an equity standpoint and from an economic standpoint. So, the next question is going to be on China. Recently the nation unveiled stimulus to help its sluggish economy. What are the potential consequences and or benefits of this stimulus for assets?
Tim Hayes
Well, they did a similar attempt to support equities in 2015 and it didn’t succeed. It’s been limited so far and that we haven’t seen the massive stimulus that would really turn around what has been the problem with China. Which has been a lack of consumer and business confidence. China has been reluctant to provide too much stimulus because they don’t want to create another bubble in property or in the market in general. This is keeping confidence very limited in that we don’t have foreign direct investment. There’s a lot of worry about regulation, government control, worry that the market, worry about the idea that the market is uninvestable. We’re just not getting the market anticipating that we’re going to see sustained recovery in the Chinese economy and until we start to see that, it would be a market to that will continue to underperform.
Jose Torres
Moving across the Pacific Ocean to the United States here, are you optimistic that US earnings growth in ‘24 will gain roughly 10% like market participants are pricing? Some headwinds are higher for longer fed and global growth slowing down. How do you feel about earnings prospects?
Tim Hayes
Well, we’ve had this soft landing, which is pretty much the ideal situation and inflation is under control. Despite the little surprise we had earlier this week and inflation trend is going in the right direction. At the same time, we’re not going into a recession in the US, so this supports earnings continuing to come through. The beat rate right now is about actually 81% of stocks have been beating expectations, which is down from 83% with about 62% of the companies reporting. So, the earnings seasons have been coming through well. The forward earnings, if you look at a year from now, are at 11% earnings growth similar to what you mentioned and 10% trailing earnings. At this point of the cycle or -3% but the point is they will trail earnings will start to follow the forward earnings. Unless some major negative surprise is out there from a macro standpoint, we do not see any signs of the earnings should come through and I think 10% would be a reasonable expectation for the year.
Jose Torres
Moving along to valuations, you know the forward earnings multiple is around 21 times here or an earnings yield of 4.8% compared to risk free fixed income alternatives that present more attractive yields of upwards of 5%, albeit without the potential for earnings growth. Does valuation present downside risks?
Tim Hayes
Not at this point. I think similar to what I mentioned earlier, if we have stocks and bonds both moving together on the upside, stocks are going to be outperforming bonds. If we do see yields continue to fall that benefit from bonds becomes less decisive. The big point is that the valuations and equities will be supportive if the earnings come through. It’s when earnings growth starts to slow and by that point in time, if we’ve had these earnings yields at these levels, then you have the potential for complacency and therefore disappointment. Then the valuations would become more of a problem for equities. At this point, I don’t think it’s an immediate concern, but we do need to pay attention to it. If we were not at the levels of valuation, we’d have in 2021, but if we did then that would start to become a concern. So yes, something we should be watching.
Jose Torres
Speaking of wild cards and potential headwinds, how are you thinking about geopolitical risks, including Hamas, Israel conflict, the Red Sea disruptions that are going on, Ukraine, Russia. How is that influencing your outlook on the marketplace?
Tim Hayes
The way to look at that when the Ukraine war broke out, heading into that even before it started, commodity prices were moving higher which had an impact. Then that became the economic impact on commodities, but if it’s more of a contained geopolitical crisis like the Middle East is at this point that doesn’t necessarily have to have an impact on the markets. It’s when it has a bigger macro impact that it becomes more of a of an impact. What we find that what we call crisis events during a crisis event, the market tends to have an initial decline within a month later, it’s back where it was before the event started. We should think about the potential for a major geopolitical event such as Taiwan and China getting into a conflict, which would then have a much bigger economic implications, which would have a much bigger market impact. If these geopolitical problems are contained, they may have a short-term impact but will not have a major macro impact. Which the markets will be able to tolerate.
Jose Torres
How are you assessing the impact of the record level of US government debt issuance and deficits, and the potential for future government debt issues and your outlook for bonds, particularly on the long end? Some folks are concerned that it’s going to be structurally higher in the medium term.
Tim Hayes
I think that does put a floor, certainly under yields, but there was a lot of worry about that in October. Then yields came back down and I think that what we haven’t seen is really the kind of inflation expectations that are needed to get bonds into a sustained uptrend. I would say the supply issue is providing a floor to yields, but we don’t think yields are moving into a long uptrend. As I mentioned earlier, if the economy is slowing well, yields will probably continue to recede as the Fed starts cutting rates. On the supply demand question, you have the supply supporting yields, but you don’t have the demand to really produce inflation expectations to you launch a major uptrend in yields.
Jose Torres
Finally, our last question, what are possible headwinds and tailwinds in markets today? We spoke about a lot of them, but I’m curious as to what’s top of mind for you.
Tim Hayes
Well, tailwind would be liquidity that will start to improve as the Fed and other central banks start cutting rates and. Moving from a tightening cycle to an easing cycle, that’s the real tailwind here for the markets. We talked a little bit about valuations, a headwind would be if the markets have gotten too complacent, has priced in too much good news and you start to get more earnings disappointments. That would be a headwind. Also remember this is an election year, there’s a potential for uncertainties or surprises to keep the market choppy. We have a cycle composite that we put together the 1- 4- and 10-year cycle to give us a road map for the year. It suggests a choppy uptrend, you have correction potential in May, September, October, but then after the election there’s a reliable year-end rally. Over the course of the year, we see the market moving higher as it’s already started to do up to this point of the year.
Jose Torres
That’s interesting! One thing that I’ve been thinking about are the pros and cons of the former president. He’s doing pretty decent in the polls, but in the short term, he presents some risks to markets. Perhaps via government shutdown but in the more medium term, the market may benefit from a more deregulatory lower corporate tax kind of regime. That’s something that we’ve been thinking about here as well. Then also on what you said about China and Taiwan, some risks that come to mind there are, semiconductors have been on a fierce rally to the upside globally speaking. While Chinas equity markets have, been in the basement. Sometimes I wonder if China is a little worried, jealous, or concerned that they’re not participating in that upside and that lays a framework for a Geopolitical event.
Tim Hayes
Yeah, that’s something I have pointed out quite a bit is that if you look at these big tech stocks and you look at Alibaba and Tencent, unlike the tech US based tech stocks have really been driving the benchmarks higher. Those stocks have been weighing down the Chinese market. They have not participated, or benefited from what has really helped the US, which has been its heavy weight in these big tech stocks.
Jose Torres
Yeah. Sometimes I think about, you know, folks being scared of having their money parked east and China. A government crackdown on capital controls or inability to get their cash out. That’s really driven more upside in Japan, Europe, and the US. It will be interesting to see how that continues to evolve in the coming months and years.
Tim Hayes
Yeah, I think that’s right.
Jose Torres
All right, Tim. Thanks a lot for participating here in the Interactive Brokers podcast. Check us out on your favorite channel for podcasts, Spotify, Apple Music. Thanks a lot for being here, Tim.
Tim Hayes
Thank you, Jose.
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