Economic growth possibly accelerating in US
Equities continued to rise in October. The third quarter earnings sea-son took off and has, so far, been stronger than expected. In the US, the rate of earnings growth has been more than +8% and in Europe more than +5%. At the same time, the global economic growth outlook is well-supported, with improved corporate earnings, a low interest rate level and central bank stimulus maintaining a global GDP growth rate of around +3.6%. In the US, GDP growth is even regaining momentum with Q3’s reported growth at as high as +3% annually. We are maintaining the equity markets’ weight at neutral, with small sales made during the year balancing out the good generat-ed by rising stock prices in the portfolios.
In October, interest rates remained within a narrow variation range in the euro zone. The ECB’s QE programme’s monthly purchases will be reduced to EUR 30 billion at the beginning of next year, but it looks like the first key interest rate hike will probably not take place until summer 2019. As we see it, the Fed’s next key interest rate hike will take place in December and it is already actively reducing its balance sheet. The size of central bank balance sheets has correlated strongly with risky asset classes following the financial crisis, so this is worth keeping an eye on.
Credit risk premiums tightened some more in October, both in Europe and in the US, with the good earnings season reinforcing companies’ outlook. Cash is currently cheap due to the low interest rates and the tightest credit risk premiums this cycle. It is not surprising either that, especially in the US, the quality of documentation for corporate bonds’ new issues (incl. covenants) has fallen significantly. At the moment, there is reason to be careful when deciding which issues to participate in. The high demand for corporate bonds is unlikely to ease up in the next few months.
The equity markets rose to new all-time highs in the US, boosted by a good start to the earnings season. The technology sector has been espe-cially strong, but also the development of the material and construction sector is good. The strengthening of the euro came to a halt, but it added some nega-tivity to the earnings outlook of euro zone export companies. All in all, the earnings season has taken off better than expected in the US with S&P 500 companies reporting earnings growth of even more than +8%.
There have been no signs of the feared earnings weakness, which has given equities room to rise to new highs in the US. At the same time, valuation levels have risen to their most expen-sive this cycle, but there are reasons behind this. In Europe, the currently reported earnings growth has been more than +5%. Earnings forecasts have carefully been raised during the Q3 earnings season, so no major chal-lenges are in store on this front in up-coming weeks. S&P 500 companies are expected to reach +11.8% earnings growth next year, and Europe’s Stoxx 600 companies +8.7% similarly.
Juhani Lehtonen, Head of Fixed Income & Market Strategy Investment Solutions