US non-farm payrolls recover as expected, with investor attention turning to the Q1:2019 earnings season
Risk assets are in general close to their early December 2018 levels, with the S&P500 slightly lower (-1.3%) than its all-time high of 2931 (see graph below). Central bank dovishness, coupled with better-than-expected PMI (China) and ISM (US) data provided support in the past week. The improvement in global growth and corporate profits are key to supporting gains in global equities, since it appears that central banks’ U-turn support to risk assets has been exhausted.
The necessity for improvement in growth and profits is more pronounced when equity valuations are demanding. Recall that the S&P500 12-month forward PE ratio has increased to 16.6x from 14.6x in early January and hovers at its 72% percentile vs its 2004-2019 average (13.2x Eurostoxx @ 55% percentile, 12.4x FTSE100 @ 46% percentile and 11.8x MSCI EM @ 71% percentile).
Regarding growth, current activity indicators (CAIs), which track the short-term economic outlook, suggest a bottoming out in activity in US and China, while they continue to decline in the euro area. Economic surprise indices (ESIs) remain below 0 both in the US and euro area, albeit they have recently improved markedly in China (above 0), suggesting that actual data releases are broadly above consensus expectations. Finally, consensus expectations for 2019 real GDP growth in the US and China have stabilized, while they continue to decline for the euro area economy (see our CAI/ESI/GDP expectations charts in page 3).
Regarding corporate profits, 12-month forward earnings (EPS) revisions by consensus analysts, albeit improving, remain in negative territory, indicating that downward EPS revisions (#) dominate positive ones (see graph below for the S&P500 – a similar conclusion applies for SXXE, NIKKEI225 & the MSCI EM index). Investor attention will now turn to JPMorgan and Wells Fargo, which are expected to open the Q1:2019 US earnings reporting season on April 12th. Overall, consensus analysts projects a -4.1% yoy decline in Q1 EPS from +13.7% in Q4:2018 and +20% yoy in 2018 as a whole reflecting: i) base effects from Q1:2018 (fueled by tax cuts); ii) lower oil prices in Q1:2019 (-13% yoy); and iii) decelerating global growth. Corporate profitability is expected to rebound in the coming quarters (+3.6% yoy on average) to reach FY:2019 EPS growth of 4%.
Moreover, headlines regarding US-China trade negotiations appear positive, with President Trump stating that an agreement is possible in the next 4-6 weeks, albeit companies may not ramp up their investment plans if there is no agreement and uncertainty remains regarding future trade relationships. Furthermore, the implemented increase in bilateral tariffs, albeit modest so far, continues to disrupt supply chains, hurting exports and investment.
Overall, the positive correlation of equity-bond prices broke down in the past week, as Government bonds lost ground from overbought levels. US Treasury yields rose by 9 bps to 2.50% (muted wage gains on Friday did not help – see Economics) and the 10Year-3month term spread re-entered positive territory at 7 bps, reducing recession “headlines”. The upward move of UST yields entrained Bunds (now at +1 bp with no ECB action expected on Wednesday but much anticipated news on TLTRO3s, outlook, DEPO tiering system), JGBs and Gilts. The political situation in the UK remains liquid, with PM May requesting a further extension (beyond April 12) to June 30. We see an increased probability of a further extension to Article 50 and snap general elections.