The Federal Reserve cuts rates for a 3rd time this year to 150-175bps, with US equity markets hitting a record high
The Fed cut its policy rate for a 3rd consecutive time by 25bps to 1.5%-1.75% at its meeting on 30th October, with two members (out of ten) opposing the cut. Chair Powell cited that monetary policy “is likely to remain appropriate”. Moreover, the post-meeting statement infers that the Committee will assess the appropriate path of the FFR going forward. Looking forward, Fed statement, together with stronger-than-expected NFP growth indicate that the cycle of insurance rate cuts since July is likely over.
Indeed, nonfarm payrolls rose by 128k in October, outpacing consensus expectations by a wide margin and the ISM manufacturing demonstrated signs of stabilization (up by 0.5 pts to 48.3), albeit remaining in contractionary territory for a 3rd consecutive month. Moreover, real GDP growth came in line with trend (circa 2%) in Q3:2019, with consumers the key players and residential investment adding to growth for the first time in seven quarters (see Economics). All in all, financial markets price-in another 35 bps in rate cuts by the end of 2020.
There were also some further encouraging signs that global growth is bottoming out. The Markit/Caixin Chinese manufacturing PMI rose by 0.3 pts to 51.7 in October, albeit the more domestic-oriented NHS Chinese manufacturing PMI declined by 0.5 pts to 49.3. Moreover, the ratio for euro area manufacturing new orders to inventory subcomponents (a leading indicator of the headline index) rose above 1 for the first time in a year. However, the headline PMI manufacturing index rose only slightly to 45.9 in October from a 7-year low of 45.7 in September.
In a similar vein, euro area growth remains lackluster, with real GDP growth of +0.7 in Q3:2019 (annualized rate – see Economics). All told, fading tail risks stemming from trade and political factors (i.e. Brexit), combined with the dovish pivot from major central banks, could support a rebound in growth in 2020 following a weak 2019, which is expected at a post-Global Financial Crisis low of 3%.
Reflecting the above developments, equity markets were higher during the past week, with the SPX over-performing and recording a historical high of 3067 (+1.5% wow and 22% YtD). The earnings season for Q3:2019, with 70% of constituents having reported, has delivered: i) positive EPS surprises, as 75% of SPX companies have surpassed consensus estimates (above the 5-year average of 72%) with the mean EPS surprise at +3.8% (below the 5-year average of +4.9%); and ii) actual EPS growth of -2.6% y-o-y following estimates of -5% at the beginning of the earnings season.
As weak corporate profitability continues in Q3, following broadly flat EPS growth in H1:2019, consensus expects a strong rebound in H1:2020, in tandem with fading trade risks and a pick-up in economic activity. These positive earnings expectations are well built into equity prices and, as a result, absolute valuations appear elevated. Indeed, the SPX 12-month forward PE ratio at 17.4x hovers 16% or 1.03x STDEV above its 15-year average. On the other hand, in relative terms, equity valuations appear less expensive when compared with fixed income, with dividend yields above government bond yields in all markets ex-EM. On a company level, circa 60% of SPX constituents offer a dividend yield above benchmark US Treasury yields as well (see graphs on page 3).