Business, Financial, stock markets, sudden technical sell-off, but the fundamentals hold
Candriam: US Equity, sudden technical sell-off, but the fundamentals hold, word to the market
Since last week, stock markets have burned most of the gains in 2018.
The stock exchange start-up in January had been too rapid and the sentiment indicators had become overly optimistic.
However, the market sell-off is more systemic than based on fundamentals. The growing fear of investors that the so-called Goldilocks scenario is about to close is unjustified and, in our opinion, a context of favorable fundamentals will eventually prevail.
Since the end of last week, equity investors have begun to monetize their 2018 earnings, initially because they are worried about a possible end to the Goldilocks scenario, and in particular, of a sudden burst of US inflation.
However, the real reason for the sudden collapse of the US stock market on Monday was a technical sell-off, not a fear of inflation, as evidenced by the decline in bond yields during the stock sell-off.
It was the result of a systematic sale and the repurchase of consistent short positions on the volatility index (Vix).
Evaluation of inflation risk and scenarios.
A far more solid expansion of the expectations recorded a few weeks ago, a renewed weakness of the US dollar and rising commodity prices are just some of the many reasons that drive fears of a return to inflation.
After almost a decade of uninterrupted deflationary surprises, the general view of a continuation of inflation below the trend is faltering. We agree with the Fed that this year US inflation should increase.
The US cycle is the most advanced in the world – as evidenced by the unemployment rate – and has received a further stimulus from the tax reform.
This made the perceptions change quickly. By the end of November, ten-year Treasury bond yields, driven by rising inflation expectations, rose sharply. However, US real yields remained extremely low, providing strong support for the economy and equities.
Candriam expects three scenarios for 2018-2019 in the United States: Main scenario (60% probability) The US bond market finally realizes that no recession is coming and quickly adapts to the path envisaged by the Fed of three increases rates for this year and three more in 2019.
In part, rising bond yields are more in tune with the increase in the value of equity securities. Looking ahead, we expect further normalization, but without overshooting, with the yield of 10-year US government bonds that could reach 3% in 2018, thanks to the strength of the Boom expansion of investments and recovery of productivity ( 15% probability).
The tax reform leads companies to invest more in a stable way (+ 10% in both 2018 and 2019) with a strong increase in productivity. In this context, inflation remains subdued and the Fed abides by its plan. Equity markets continue to grow, supported by earnings increases. Long-term rates increase as the rate of potential growth increases and do not cause the economy to slow down.
Fear of inflation and decline in equity markets (25% probability).
The markets suddenly realize that the Fed is behind the curve and begin to fear a surge in inflation: long-term interest rates rise significantly, causing a decline in the stock market.
Is this fear primarily based on inflationary expectations, rather than on actual inflation data? No fear of inflation in the Eurozone Outside the United States, however, there are few signs of inflationary pressures.
In particular, the situation is very different in the Eurozone, where inflation is likely to converge very gradually towards the 2% target set by the ECB.
The data published in January, with the annual consumer price index dropped to 1.3% (and the core index at 1%) confirmed a weak inflationary trend.
The upward movement of the currency in the last 12 months is further easing tensions.
Looking for a favorable entry point.
For the time being, there is no reason to question our basic scenario. In fact, we expect that the context of Goldilocks will prevail throughout 2018, thanks also to the continued support of the fundamentals.
Actions have become even more interesting after the recent correction. The US equity markets currently trade at a multiple of 17x profits for 2018, while just a week ago the forward P / E still stood above 20 times.
Finally, strong earnings growth should continue to support the performance of equity markets. In this fundamentally sound market environment, and although we may see a second wave of systemic sales, we are looking forward to a stabilization of market dynamics and a propitious moment to further increase our equity exposure.
* CFA, Candriam Investors Group’s Head of Asset Allocation “The content of the news and information transmitted under the heading” Word to the market “can in no case be considered a solicitation to the public savings or the promotion of any form of investment nor personalized recommendations for any form of financing.
The analyzes contained in the news transmitted in the specific section are elaborated by the company to which the subject expressly indicated as an author belongs.
The news agency Il Sole 24 Ore Radiocor disclaims any responsibility for the truthfulness, accuracy and completeness of such analyzes and therefore invites users to take note with attention and due diligence of the above stated and represented by the company ” .
by Nadege Dufosse (Il Sole 24 Ore Radiocor Plus)
Milan, 08 Feb 18
Source Borsa Italiana
