Last fortnight witnessed significant volatility in global equity markets. Between Jan 26, 2018 and Feb 09, 2018, S&P 500 fell by almost 11.50%, having a cascading effect on stock markets around the world. The quantum of fall is bound to create panic and nervousness, but more importantly a confusion in the minds of investors on what should be the future investment strategy.
I am not sure how many of us would remember that post Global Financial Crisis, S&P 500 has witnessed more than ten percent correction on two more occasions, with multiple smaller falls. The first was between June and September of 2011 when S&P 500 corrected by 14.3% and the other was in August 2015 when the correction was about 11.1%. The 2011 nervousness stemmed from the downgrade of US sovereign rating for the first time from AAA to AA+. It was however relatively short lived for 4 months (Jun-Sept 2011). The 2015 volatility lasted a bit longer for about 7 months (Aug 2015 – Feb 2016) as the events were multi-fold. We saw the Chinese stock markets collapse, Greece’s inability to service IMF debt, crude touching a low of USD 27 and the noise around referendum for BREXIT picking up. However, since the low of 2011, S&P500 is up by more than 125% and around 36% since 2015 bottom.
This leads to next point of discussion of why this time it should not be too different and thus should be not be a concern for panic. I hear people mostly worried about US10 year treasury yields moving up by about 80 basis points to c. 2.80% and PE multiples hovering at around c. 21x – leading many to believe that these are numbers that are getting a little out of comfort zone. It may here be relevant to have a look at the macro-economic environment in the high-growth phase of 2003-2007. During this phase, 10 year yields moved from 3.51% to 5.02% and inflation rose from 2.1% to a peak of 4.7%. But these numbers got overshadowed because the corporate earnings also doubled during this phase.
Fast forward to 2017 and one sees 96% of the employable population in US now employed, earnings growth has picked up momentum in 2017 (after a very modest earnings growth for 5 years between 2011 and 2016) and at 77% capacity utilization, US corporates have enough room for growth, atleast for next couple of years, without getting too worried about investing in capex.
So how does the next couple of years (2018, 2019) look like? Of about 294 of the 500 S&P companies that have announced their Q42017 earnings, almost 80% of them have exceeded earnings (this is much higher than about 55-60% that have been exceeding expectations in the recent past). Domestic growth drivers may also get some support from exports growth likely to pick up strength from weaking dollar. Trump’s trade policy has been pretty aggressive. US dollar index has come down by more than 10% in 2017. From a peak of 102.21 at the beginning of 2017, it has now been hovering around the 90 handle (in fact, it touched a low of 88.52 in January 2018). Tightening monetary policy in Europe could prevent USD from appreciating significantly.
What this means is that US corporates would have a dual support from growing domestic demand and weak dollar that would potentially drive exports. Revenue growth is likely to get further support from corporate tax reforms. Recent earnings strength is leading to re-forcasting of 2018 estimates. Consensus is moving towards 15+ per annum earnings growth in 2018 / 2019. It would therefore only be wise to track the earnings number for March and June of 2018 quarters. Any strength in earnings should be used as opportunities to invest.
Definitely, this is not the time to get panic and exit. If not increasing investment, definitely to remain stay put.
What this means for Indian equity markets? Keep following this space.