As we expected, the US Federal Reserve did not alter their stance at their meeting last week. The Fed acknowledged the ongoing slowdown in US growth, but declined to take any additional action. There were hints that the Fed might elect to do more at its next meeting in mid-September if the country’s economic trajectory does not change.
Policy unchanged
In Europe, the European Central Bank (ECB) voted to leave its benchmark interest rate unchanged, but perhaps more importantly, ECB President Mario Draghi indicated that the central bank was working on plans to purchase sovereign bonds in the secondary market.
The bank’s intention is to join forces with Eurozone governments to support sovereign debt markets and to stabilize the region. Europe remains in the middle of a long-term crisis as the region tries to navigate between the competing demands of austerity measures and growth needs.
President Draghi’s statements were certainly a step in the right direction, but more still needs to be done, particularly in terms of adopting a more flexible monetary approach and pushing for a closer fiscal union between the region’s countries.
Looking ahead, it seems clear to us that the driver of capital markets will continue to be the extent to which global policy support will be able to offset the ongoing deflationary pressures of private-sector deleveraging and fiscal retrenchment. The bearish case would be that policy actions will not be effective, or worse, that policy will exacerbate economic risks and intensify deleveraging risks. We do not subscribe to this outlook, but acknowledge that policymakers have a difficult task ahead of them. Ultimately, we believe policymakers will be able to provide the support necessary to reduce the downside risks and to help get the global economy onto a more sustainable growth path.
Over the past three years, US stocks have been enjoying a bull market, if one that has been punctuated by several sharp corrections. In our view, the bull market should continue, but as we indicated earlier, ongoing policy help remains necessary. As long as economic growth manages to remain at least somewhat decent, corporate earnings should hold up.
Risk-on the way to play current macros
On that front, we are now more than two-thirds of the way through the second-quarter earnings season and while overall earnings have been slightly beating expectations, revenues have been disappointing and forward guidance has been weak.
At the beginning of the year, we had a forecast of $103 for S&P 500 earnings per share, and we would hold to that view. Such a number might not be stellar, but it should be enough to help stocks continue to make gains.
Outside the US, the outlook is a bit murkier. Non-US stocks have struggled to stay range-bound, reflecting both weakness in the euro area and lacklustre levels of growth in emerging markets. European equities may be poised for a rebound, particularly if we should see aggressive policy support from the ECB and other policymakers. That region’s poor corporate earnings outlook, however, is likely to remain a drag on performance for some time.
One area we are watching carefully is emerging markets – emerging market equities appear to be positioned for an upgrade once we see improvements in emerging markets and global economic growth.
Overall, we would view the combination of below-trend growth and very easy monetary policy in most parts of the world as a positive backdrop for stocks. Despite the well-known risks, we believe a modest risk-on strategy continues to make sense for investors.
