All that glitters

On the surface, everything in the equity world appears lustrous. So far this year, global equities are up by around 4% in aggregate and the best-performing regions, notably Europe and Japan, have risen by at least twice as much.

But scratch beneath this gleaming façade, and the picture becomes a bit less alluring. Corporate earnings estimates, with the notable exception of Japan, have taken another lurch lower, valuation levels are becoming less compelling (especially in the US) and investor sentiment surveys suggest that the bears have gone back into hibernation en-masse. Even the prospect of a pick-up in global aggregate demand in coming months will have, at best, an ambiguous impact on asset prices and volatility.

Lacklustre corporate earnings growth is a particular concern. At the start of the year, consensus forecasts for global profits growth, as measured by I/B/E/S (Institutional Brokers’ Estimates System) was around 9%. As we head towards the end of the first quarter of the year, that number has more than halved.

Profits forecasts lose their shine

Admittedly, the bulk of this attrition has been driven by trends in the US, where the impact of the oil price slump on the energy sector and a resurgent dollar have taken the shine off earnings forecasts. But these factors by no means capture the whole story. Many other S&P 500 sectors beyond energy are experiencing weaker earnings trends (notably consumer staples, telecoms and industrials), while in other corners of the globe, only Japan stands out as a beacon of light in an otherwise uniformly gloomy scene.

Unless there is a meaningful upturn in global aggregate demand in the coming months, then we are likely resigned to yet another year where weak pricing power and limited sales volume growth leads to a lack of profit support for already elevated equity prices.

Central bank policies driving markets (for now)

The principal driver of equity gains still seems to be central bank largesse in the form of both quantitative easing (QE) and more conventional interest rate adjustments. The two potential problems that arise from this circumstance are, firstly, that the monetary authorities are rapidly running out of ammunition and second, the essence of QE is that it is redistributive, from one region to another, rather than necessarily additive to the whole.

For the time being this redistribution gambit favours Europe and Japan, two of the regions where we have been carrying overweight positions for several months. There are few reasons to believe this situation will reverse itself in the immediate future, even allowing for some overbought parts of the market.

So enjoy the ride while it lasts. QE is clearly still driving a vast army of investment refugees into riskier assets. This increasingly Pavlovian search for yield in response to derisory interest rates will not go on forever. But the longer it lasts, the larger the number of investors that could find themselves holding “fool’s gold”.

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