Rollercoaster of expectation changes
We are hopeful that the substantial improvement in business sentiment over the past 12 months will counterbalance the slight flagging of consumer demand, resulting in still healthy earnings growth. This may be sufficient to underpin current stock market valuation levels in the US and provide further upside dynamic for the lower valued European and Asian markets. This has also the potential to change recent exchange rate parities. If Europe and Asia overtake the US in growth terms, then there is in our view a high probability that the US$ will continue to decline from the high it reached at the end of last year.
Either through currency movements or market gyrations, we expect the capital market leadership to pass on from the currently very optimistically priced US stock market.
UK consumer demand has, similarly to the US, slowed, but business sentiment is improving. The latter is most likely to do with the economic acceleration in the Eurozone, with UK businesses currently enjoying the paradoxical, yet enviable position of still being part of this biggest free trade zone in the world, while operating with pricing advantage of a currency that has already substantially devalued in anticipation of leaving the EU in 2 years.
Why currency moves matter in 2017
We expect the US economy to lag behind that of Europe, Japan and Emerging Markets (particularly China) in the short to medium term. The 3% currency depreciation may indicate that we are not alone with our expectations. The lagging effect could very well continue to pass on to the dollar, as capital is diverted away from the US. Given these factors, our conviction that the US$ will likely weaken not strengthen significantly in the near term has further increased – despite the apparent upward pressure from the Fed and Trump’s expected policies.
For 2017, we expect currency moves to matter more than usual, as they may generate bigger value differentials than the regional stock and bond markets. Just as £-Sterling based investors learned in 2016, such shift can be substantial. For this year, we expect the value of £-Sterling to remain under pressure.
Q1 2017 corporate earnings look stronger, but what’s priced in?
On current analyst consensus expectation numbers, the first quarter of this year is tracking even stronger than the last quarter, driven by improvements in financials and energy/commodity sectors. We see a possibility that earnings will come in stronger than consensus currently anticipates, given the generally cautious nature of company guidance and the supportive impact of a steady upward trending economy.
Following the recently receding stock market momentum, the Q1 earnings results will provide crucial evidence for investors as to whether their regained confidence in the stock market is justified, and whether extended valuations in the US are underpinned by continued earnings growth momentum.
We believe that there is potential for companies to positively surprise relative to expectations, on the back of high operational gearing (to an improving economy), the base effect of higher commodity prices, better corporate pricing power and still supportive credit conditions during Q1.
Oil prices – back to stable?
The upcoming summer ‘driving season’ in the US and continued strong demand from China provides support to the view that the rebalancing of supply and demand in the oil market is now really progressing. When we add in the fact that speculative net long positions (fast money) have materially reduced, this could mean a reduction in near-term price volatility, or stabilisation in the mid-50 $/bbl, as at the beginning of the year. More stable and not excessively high or low oil prices will constitute another positive factor for the economy, because it improves planning certainty and thereby increases business’ willingness to invest.
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