Is this as good as it gets?
The US share market had a challenging June with the S&P falling 3% from its mid-month high before starting a slow recovery. As at 9 July 2018 the S&P500 was still 4.10% below the high reached at the end of January 2018.
The US economy has just completed an outstanding second quarter with annualised GDP growth now at 3.40%. The last quarter also saw record high increases in corporate earnings of c.25% y.o.y, but is this sustainable? This outstanding growth in earnings has come on the back of record low interest rates, and tax cuts, both of which are now in the past. The Citigroup Economic Surprise Index for the US, which tracks how data is stacking up against analyst forecasts, turned negative at the end of June 2018 for the first time since September 2017 following a string of weaker than expected US economic data.
We are now seeing S&P500 earnings per share forecasted to fall over the next five quarters. We also anticipate that the increasing risk of trade wars will negatively impact corporate earnings. Still, other measures of US economic growth remain strong, such as record low unemployment rates and rising wage inflation (c.2.80% y.o.y to June 2018).
As stated above, the US share market continues to track sideways, and we continue to recommend caution as we await some semblance of realistic pricing in share valuations as the euphoria of the past year wears off.
Global trade war is escalating
President Trump has vowed that “trade wars are good and easy to win”, and on Friday 6 July 2018 the US announced a further 25% tariffs on US$34 billion of Chinese products, which once again was quickly countered by the China State Council announcing the same percentage tariff on the same level of US goods. The tit-for-tat continues and the increased uncertainty is now pushing the global purchasing manager index closer to contraction (below 50) as new orders continue to drop.
China now has 659 types of US goods subject to tariffs – up from 106 in April – and they continue to reinforce that it is the US that is provoking this trade war and they are simply retaliating. This is obvious in the fact that all China’s tariffs are the same level as the US and are being implemented on the same day. The only difference is that the US has stated the tariffs are essential to prevent further “unfair transfer” of American tech and IP to China, while China is specifically targeting tariffs at States that were strong supporters of President Trump in the 2016 election.
In the first week of July we saw investors selling out of US stock funds and ETFs to the tune of US$24.2 billion with funds flowing into US Treasuries surging to a 10-year high. This may be due to the increased risks of the trade war escalating and investors rebalancing away from shares, capturing some very attractive share gains into bonds and cash. Given this, the support for share prices at current levels in the US may cease, leading to a decline in the US share market.
So far, the tariffs represent a small portion of US/China trade, hence the economic impact is not meaningful to date, but if this continues to escalate there could be a material slowdown in the growth of both economies, which will likely echo around the globe.
China officially entering bear market
With a slowing Chinese economy, as well as a negative impact from the escalating US/China trade war, we have seen the share market in China fall. As at 29 June 2018, the Shanghai Composite index has fallen just over 20% from its high reached in mid-January 2018 – meaning it has officially entered “Bear Market” status. The Shanghai index is down almost 11% from a year ago (ending 2 July), versus the US share market (S&P500) which is up 11.9% over the same period.
Since the Shanghai market’s previous high, reached in June 2015, the Shanghai Composite index is now down almost 46% versus the US S&P500 which is up 29% over the same period. If share markets are a measure of who is “winning” this trade war, the US is currently out front by a big margin.
The decline of offshore bonds
Rising interest rates globally are proving to be a strong headwind for performance from the US bond sector. The Bloomberg Barclays bond indices prices are down c.5% for Investment Grade and 2.5% for Junk Bonds (High Yield) since the start of 2018. This does not include any coupon (interest) payments from the bonds.
As the price of these bonds continues to fall, the yields (return to maturity) are rising. As an example, the US Investment Grade index is now yielding 4.00% per annum, versus 3.25% at the start of this year. We continue to monitor the bond sector to identify a good point to increase our exposures as these yields continue to rise.
Closer to home – NZX
We have seen a continued rally in the NZX50, up 17.5% over the past 12 months, and 15% per annum over the past five years, ending 30 June 2018. The Price to Earnings ratio (PE) for the NZX50 is now back to record high levels of 24.7X. This rally is on the back of increased global risks and an arguably slowing New Zealand economy. The June 2018 ANZ Business Outlook survey showed that firms’ own activity is continuing to decline and their year-ahead profit expectations weakened from -8.5% to -13.2%.
The ANZ NZ Confidence Index, which measures business expectations and intentions, and consumer sentiment continues to lose steam, suggesting GDP in New Zealand could move below 2.5% later this year. Even with this negative data the local share market continues to defy gravity and push higher.
We continue to recommend investors in the local share market proceed with a great deal of caution as the market continues to climb higher. Warning lights are certainly flashing in the local share market, it is simply a matter of what might be the catalyst for a fall in share prices.