By Marco Bonaviri - Senior Portfolio Manager
DON’T FIGHT THE FED
Without a doubt the last two months will enter the pantheon of memorable financial market episodes: the worst December since 1931 followed by the best January since 1987. If there is one thing this turnaround has demonstrated, it is that the main driver of risky assets is not earnings forecasts, macroeconomic data, politics, or even lines on charts; no, the only thing that really matters is the amount of money injected into or withdrawn from the system by the US Federal Reserve (the Fed), that is, whether Jay Powell is hawkish or dovish.
The anticipation of a pause in the Fed’s monetary tightening cycle and the easing of fears over the dry-up of global liquidity reinvigorated investor sentiment and fuelled the strongest rally in 40 years. The flip side is that this monetary policy U-turn is now priced in and investors may well again focus on economic fundamentals and business prospects. This is where the problem lies: we observe a surprising divergence between the consensus of company profit growth and the receding economic outlook for 2019 and 2020.
Normally, it is the dynamic of earnings revisions that strongly influences stock market trends. When stock analysts revise their growth expectations upward, investor confidence and risk appetite strengthen, pushing stock market indexes higher. However, financial markets may disconnect from the earnings per share (EPS) momentum and focus on other factors. According to our analysis, this is precisely what has happened since the beginning of the rebound starting on Christmas Eve: EPS growth forecasts have been sharply revised downwards in all markets while the S&P 500 has advanced more than 17% (Exhibit 1). Surprisingly, it doesn’t seem that this dichotomy has caught the attention of investors at this time, who are far more interested in the Fed and the linear rise in indexes.