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Investor Education > Market Commentary

23 November 2017

Aging Bull

By Marcus Tuck, Head of Equities - Mason Stevens Ltd

The global equity bull market has remained intact through 2017 to date, the ninth year of recovery, underpinned by a synchronised global economic expansion, growing corporate earnings and still low inflation and interest rates. The possibility of tax cuts in the US, including a possible reduction in the US corporate tax rate, has also helped.

Geopolitical tensions, particularly around North Korea, have been largely ignored by financial markets, where the focus is more on earnings and interest rates. PE ratios are fairly elevated in absolute terms but are not unreasonable compared to low bonds yields. In other words, the equity risk premium is not yet dangerously low.

The latest US earnings season has been surprising on the upside. Nearly three-quarters of US S&P 500 companies reported profit results in Q3 2017 that exceeded market expectations, according to FactSet consensus data. Two-thirds reported sales above expectations. Both earnings and sales growth are positive and being revised up slightly, which is positive for the US equity market.

The consensus earnings growth forecasts for 2018 can be seen in the chart below. S&P 500 earnings growth is expected to be around 11%. Above-market-average earnings growth is expected to occur in the Energy, Materials, Financials and Information Technology sectors, which is where most of the active tilts are being placed. They are all pro-cyclical, consistent with the pick-up in US and global GDP growth that is occurring.

The technology sector continues to power ahead. Eight of the world’s twelve most highly valued companies are technology businesses. Most of those tech juggernauts are American (Apple, Alphabet, Microsoft, Amazon and Facebook), but two are Chinese (Alibaba and Tencent Holdings) and one is Korean (Samsung Electronics).

Many worry that such tech dominance is setting up another “tech wreck”, as occurred when the dotcom bubble burst in 2000/01. However, there are some major differences between now and then. Most of the large tech companies are solid businesses generating real profits and cash flows, rather than just promises of future profits. As a result, equity valuations are a lot less stretched than during the dotcom bubble.

Some of the valuations might still turn out to be excessive. But in many cases the PE ratios are similar to the expected compound annual growth rates in EPS over the next 3 years. Amazon stands out as the stock with the highest near-term PE ratio but it is being bought on much longer timeframes given its market dominance in certain sectors and disruptive potential in others.

Bond yields are much lower this time too, justifying higher PE ratios all other things being equal. Back in 2000/01 US 10-year Treasury yields were around 5-6%, compared to about 2.3% now. The wider spread of tech companies between the US and Asia is also a healthy development. The businesses in which the tech companies are engaged are different in many respects or are geographically separated, ranging from software, computer hardware, mobile phones, semiconductors, televisions, online retail, media (including social media), gaming, search and advertising.

For as long as earnings are growing and interest rates/inflation stay fairly low, equity markets can remain supported. Bull markets rarely end in a mood of caution where markets slowly grind higher. They often “melt up” before they melt down. Caution gives way to euphoria and “buyer panic” sets in, with investors fearful of missing out. That would be a clearer sign that the end is near.

Global GDP growth in 2017 and 2018 is likely to be the best since the GFC. This more uniform expansion has already caused a remarkably smooth rally in global equity markets, with the MSCI All Country World Index rising for a record 12 consecutive months. The Australian share market has lagged several of its international peers, highlighting the importance of being internationally diversified.

Although we are overdue for a return of volatility, some fairly solid fundamentals for equity markets (except for falling interest rates) are still largely in place. The bull may be aging but he’s not done yet.




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