With a recession to be avoided and earnings growth to return, we believe global equities have further to go. We see stock markets reaching new highs going forward. First, a macro environment in which GDP growth is below but close to trend suits global equities just fine. In addition, financial conditions remain loose as a result of the very accommodative stance of central banks.
Since the financial crisis in 2008, global markets have moved in tandem with central bank balance sheets, which will start rising again after a two-year break. With the US yield curve suggesting that a US recession is more likely after 2020, equities have room to extend the bull market.
Historically, stock prices kept rising for an extended period of time of almost a year after every instance of the yield curve inverting (except for 1973). Prices peaked on average less than six months prior to a recession.
Second, earnings growth is set to return in the first half of next year. Diminishing uncertainty with regard to economic policy, as well as better manufacturing PMIs, will enable earnings-per-share growth to turn positive again. Earnings revisions, which remain at subdued levels today, could revert strongly once the cycle turns. Unit labor cost growth, which is negatively correlated to profit margins, will stay muted.
Wage growth is still relatively benign and productivity growth is finally rising. The tailwind of buybacks on earnings per share will dwindle somewhat, partly because of stronger investment growth. We do not believe this will keep equities from rising, though. As long as bond yields stay low or negative, companies will be enticed to swap equity for debt.
Third, investor sentiment is far from exuberant. As John Templeton once put it, “Bull markets… die on euphoria”. Currently, we are far away from a euphoric state of equity markets. Cash positions of global fund managers remain significantly above average, which is a contrarian bullish signal for stocks. In general, investor positioning is defensive.
Credit spreads also remain well behaved, with the BBB-AAA spread just below average. If anything, exuberance seems to have skipped equities and moved to less liquid, alternative investments like leveraged loans and private equity.
Fourth, equities do not look expensive in a multi-asset world. The equity risk premium has been consistently high in recent years as global bond yields continued to fall. Today is no different, with the equity risk premium still firmly in the first quartile. Historically, on an annual basis, equities have realized the best returns when the equity risk premiums have been the highest.
From an absolute level and based on realized P/E, valuation does not look demanding. The realized P/E ratio for the MSCI World Index is somewhat below its long-term average, driven by discounts in Europe and Japan.
Our alternative scenario features a US recession. Political uncertainty will not decrease or may even worsen and global manufacturing PMIs will not improve, pushing earnings down further. As a result, capital expenditures will not increase, but more importantly, a default cycle will begin as low-rated companies cannot pay off their debt.
Unemployment will rise and consumer confidence will break down. Even though there are few excesses in the economy, corporate debt being the exception, the economy will slip into recession. With central banks having less room for recession-countering measures than in the past, stock markets are likely to decline more than 20% under this scenario.
We expect global GDP growth to continue at a pace that is below but close to trend. After a slow start of the year, growth will gradually pick up. Manufacturing PMIs will improve as the inventory overhang is left behind. Earnings growth will turn positive in the first half of the year, helping sentiment that is currently far from exuberant.
Together with an attractive valuation relative to other asset classes, global equities are bound to make new highs before perhaps struggling towards the end of the year as recession fears start all over again.
The Robeco Capital Growth Funds have not been registered under the United States Investment Company Act of 1940, as amended, nor or the United States Securities Act of 1933, as amended. None of the shares may be offered or sold, directly or indirectly in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act of 1933, as amended (the “Securities Act”)). Furthermore, Robeco Institutional Asset Management B.V. (Robeco) does not provide investment advisory services, or hold itself out as providing investment advisory services, in the United States or to any U.S. Person (within the meaning of Regulation S promulgated under the Securities Act).
This website is intended for use only by non-U.S. Persons outside of the United States (within the meaning of Regulation S promulgated under the Securities Act who are professional investors, or professional fiduciaries representing such non-U.S. Person investors. By clicking “I Agree” on our website disclaimer and accessing the information on this website, including any subdomain thereof, you are certifying and agreeing to the following: (i) you have read, understood and agree to this disclaimer, (ii) you have informed yourself of any applicable legal restrictions and represent that by accessing the information contained on this website, you are not in violation of, and will not be causing Robeco or any of its affiliated entities or issuers to violate, any applicable laws and, as a result, you are legally authorized to access such information on behalf of yourself and any underlying investment advisory client, (iii) you understand and acknowledge that certain information presented herein relates to securities that have not been registered under the Securities Act, and may be offered or sold only outside the United States and only to, or for the account or benefit of, non-U.S. Persons (within the meaning of Regulation S under the Securities Act), (iv) you are, or are a discretionary investment adviser representing, a non-U.S. Person (within the meaning of Regulation S under the Securities Act) located outside of the United States and (v) you are, or are a discretionary investment adviser representing, a professional non-retail investor. Access to this website has been limited so that it shall not constitute directed selling efforts (as defined in Regulation S under the Securities Act) in the United States and so that it shall not be deemed to constitute Robeco holding itself out generally to the public in the U.S. as an investment adviser. Nothing contained herein constitutes an offer to sell securities or solicitation of an offer to purchase any securities in any jurisdiction. We reserve the right to deny access to any visitor, including, but not limited to, those visitors with IP addresses residing in the United States.
This website has been carefully prepared by Robeco. The information contained in this publication is based upon sources of information believed to be reliable. Robeco is not answerable for the accuracy or completeness of the facts, opinions, expectations and results referred to therein. Whilst every care has been taken in the preparation of this website, we do not accept any responsibility for damage of any kind resulting from incorrect or incomplete information. This website is subject to change without notice. The value of the investments may fluctuate. Past performance is no guarantee of future results. If the currency in which the past performance is displayed differs from the currency of the country in which you reside, then you should be aware that due to exchange rate fluctuations the performance shown may increase or decrease if converted into your local currency. For investment professional use only. Not for use by the general public.