Will markets extend their record-breaking run into 2020? Watch what corporate profits tell us
- Despite a recent surge, stock markets are roughly where they were before last year’s drop-off
- Investors should watch what companies are saying about global conditions to anticipate what’s next
Records are there to be broken, as the saying goes, and not just among investors. Following the strong rally since the start of this year, global stock markets now seem to be in the process of breaking the record highs set in 2018.
Other regions have seen falls of similar magnitude, with US profits growth now expected at less than 4 per cent, while closer to home Asia-ex-Japan profit growth has dropped to 5 per cent.
This means that the strong equity market returns year-to-date are entirely due to rising price-to-earnings ratios. For instance, the 12-month forward P/E ratio on Asia-ex Japan stocks has risen to just over 13.5x today, from a low of less than 10x at the start of the year. Admittedly, this only takes valuations back to where they were in early 2018, but that was when the growth outlook was brighter than today, and it is appreciably above the long-run average of 12x.
Similarly in the US, the 12-month forward P/E ratio is now at nearly 17x, compared to a long-run average of around 15.5x. To be fair, these valuation levels look “somewhat stretched” rather than “crazy”, but it looks unlikely that further rises in valuations can now be the main driver taking markets higher, given how uncertain the economic outlook remains. What markets now need most of all is better news on profits.
Fortunately, there does seem to be some good news on the horizon on this front. Earnings downgrades seem to be coming to an end across the globe, with expectations stabilising in recent weeks. And the mid-single-digit growth rates now predicted for most regions seem commensurate with the current mediocre-but-not-terrible macro environment.
In a few cases, most notably the US and perhaps even Japan, growth expectations in the low-single digits now even look a little too pessimistic, which might allow for some limited positive surprises.
One remaining worry is analysts’ too-optimistic outlook for 2020. They currently predict an unrealistic re-acceleration and doubling of the profit growth rate back to the double-digits. Of course, 2020 is still a way away and investors may not worry about this issue until later this year. Still, as these expectations come back down to reality, this should be a headwind to sentiment and another reason why one should be sceptical that stock market valuations will rise significantly.
The corporate reporting season that is under way across the globe offers insights into how companies themselves see the profit outlook. After the steep downgrades in forecasts, results for the first quarter are likely to surprise pleasantly, as analysts often overshoot in both directions.
Patrik Schowitz is a global multi-asset strategist at JP Morgan Asset Management