Earnings season wound up successfully – equities still under scrutiny
Equities moved horizontally in August following a successful second-quarter earnings reporting season. The earnings season went well in the US, Eu-rope and the emerging markets alike. The continued weakening of the dollar has, however, gnawed away at yields on the US equity markets from the euro-investor’s perspective (S&P 500 index from the start of the year -0.6% in euros vs. +11.9% in dollars).
Price volatility rose on the equity markets in August from its multi-year bottom and the allocation of new as-sets in equity funds in Europe and the US fell somewhat. We will maintain the weight of the equity markets at neutral in our allocation but we have down-graded our equity weight slightly after the summer.
Interest rates began to fall once again in August with risk appetite experiencing a few hiccups to compensate. The yield level on Germany’s 10-year government bond fell back down to +0.36% and the yield on the US 10-year bond fell to +2.12%. The expectant mood on the fixed income markets continues with news on the winding down of the balance sheet stimulus programme anticipated from the central banks over the next few months, and with high demand on the corporate bond markets still pushing credit risk premiums towards the tight levels preceding 2007. A relatively large amount of assets can still be found in cash globally, with investors maintaining a good-sized cash buffer in hopes of broader yield levels.
In Europe, the ECB’s stimulus programme is still in control on the corporate bond markets and we expect information in September or October on the timing of the reduction of the QE programme scheduled to begin next year. Similarly, in the US, the Fed is expected to report in October, at the latest, at what pace it in-tends to reduce its balance sheet. We do not foresee any major market impacts in the short term, but in the long run it is a well known fact that growing the balance sheets of central banks has correlated strongly with good return development in risky asset classes.
The equity markets stood still in August in the Western markets but emerging market stock markets continued to rise. A successful Q2 earnings season is behind us and, in the short term, many factors other than the basic fundamentals are currently driving the equity markets forward. The tightening of geopolitics in Asia and the challenges linked to the raising of the debt ceiling in the US have kept investors on their toes in August. In the long term, the valuation levels for the equity markets are at their most expensive for the current cycle. On the markets, expectations for the continuation of positive earnings growth are discernible in prices. Earnings growth of +11% is predicted for next year on the S&P 500 index in the US and earnings growth of more than 12% for the broad European Stoxx 600 index.
In the real economy, GDP growth prerequisites continue to be positive glob-ally: central banks are continuing their stimulus measures, interest rates are low, consumer demand is at a good level and no significant inflation pressure is in sight. There is, however, reason to keep an eye on the overall equity market set-up against elevated valuation levels now that in-creased political risks are the main topic of conversation on the markets.
Juhani Lehtonen, Head of Fixed Income & Market Strategy Investment Solutions