Main indices in the US and Europe are disproportionately damaged by bad news from manufacturing and energy, while at the same time being slow to benefit from consumer-led growth, according to Flanders, chief market strategist for Europe at JPMAM.
This is because the main regional equity markets in both the US and Europe are much more dependent than the domestic economies on the commodity and manufacturing sectors.
“With energy and mining firms contributing 20% of profits in Europe and 10% in the US, it should not be a surprise that falling commodity prices have seen equity markets suffer,” explained David Stubbs, JPMAM global market strategist. “The market’s much heavier reliance on the manufacturing sector has also taken its toll on corporate profits.”
In addition, the US and European equity markets are relatively underexposed to the uptick in consumption, as they source a relatively small proportion of their profits from domestic consumers. And since the S&P index is so exposed to manufacturing, recent developments hurts index-focused investors the most.
Interestingly, Flanders also points to how three of the key market trends of the past 18 months – the strong dollar, falling commodity prices and serial poor performance by emerging markets – all reversed during the first quarter of 2016.
“It’s too soon to say whether this will last. Emerging markets still have work to do improving their economic fundamentals, and the dollar could strengthen again later in the year, if investors revise up their expectations for rate increases in the US. But for active investors, it’s probably a risky time to be underweight EM,” she said.
Growth worries linger on both sides of the Atlantic, and with the corporate earnings story still depressed, the trade-off between risk and reward is less attractive now than in earlier stages of the cycle, at least for equities, in Flanders’s view. Given that backdrop, it would make sense for investors to have a more balanced portfolio than in earlier stages of the bull market and to lower expectations for overall returns.
In line with this and since the risk/reward trade-off on equities is less attractive, JPM keeps a neutral weighting to both equities and bonds at the moment.
