30 Nov Boom & Gloom: November 2015
Our view of the investment markets
This table reflects our view of the relevant assets, based on expected performance.
The domestic market has been slaughtered over the past months, especially the resource stocks. The Swix 40 Index is trading at a rolled 1 year PE of 16.9. Earnings are expected to grow 6.6% in year 1 and 15.8% in year 2. The rating in the market is fairly demanding and earnings growth is subdued over the shorter term. Consensus earnings revisions have turned positive in the last month. Our 1 year total return is 2.8% with risk to the upside over the medium term.
Volatility has recently become the norm as growth and monetary policy uncertainty play out. The US equity market is displaying irregular behaviour and has become very difficult to read. Strong economic surprises prompt rallies in anticipation of stronger earnings growth and, at stages, sharp draw-downs occur in fear of rising interest rates.
The reality is that the S&P 500 Index is at average valuation levels; the 1 year rolled PE stands at 16.6 times earnings and 2 year rolled PE is at 14.8 based on bottom-up consensus expectation. This implies rolled earnings growth of 6.9% 1 year forward and 11.5% for the 2nd year rolled. Our top-down models expect earnings to grow 10.1% 1 year forward based on consensus US real GDP, PCE and a EUR/USD of 1.05. The negative momentum in global growth expectations tilts earnings growth risk to the downside. The consensus earnings revision momentum has turned positive over the last month.
S & P 500 Index historical PE
S&P 500 Index ROE is below the long term average (of 16.3%) at 15%, so there is upside potential. The index leverage is fairly low at 25%, as opposed to being close to 40% in 2007. The index operating margin of 12.3% has drifted from the high of 13.9% in 2014, this was also the case with the return on assets.
Market implied risk, using the VIX Index, has recovered from the spike in August 2015. However, the potential impact of interest rate hikes in the US elevates investment risk in the market. We’re expecting a USD return of 6.7% for the index.
The European market – which is a high beta market – has been supported by domestic fundamentals, notably low interest rates and the potential to stay low for an extended period. The low interest rates are keeping the cost of equity low, justifying relatively high PEs. The Euro Stoxx 50 Index 1 year rolled PE is 14.1 times earnings. 1 year earnings growth is estimated to grow around 6% in year 1 and 10.1% in year 2. We estimate a total 1 year return in EUR of 9.3%, with forecast risk to the upside.
Japan and Asia
The Japanese equity market is trading at a rolled 1 year PE of 17.7. The market had a lot of support from the asset allocation shift into equities by the Japanese Government Pension Investment Fund and the weak Yen. Consensus expects earnings to grow 13.7% rolled 1 year, however the subdued Chinese growth is flowing through into the Japanese market and we see negative risk to the growth number. The earnings revision momentum is negative at this stage. We see limited rating upside due to China risk and expect a 1 year total return of 9%, we place a high risk on this number.
Total return to 9/11/2015
Total return to 9/11/2015
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