Manager Insight: Earnings recovery could push U.S. market higher, Fidelity strategist says

first_img Franklin Templeton renames funds with new managers NEO, Invesco launch four index PTFs Change to Counsel Global Small Cap Fund Michael Ryval Even though the benchmark S&P 500 Index has set record highs this year, Jurrien Timmer, the Boston-based director of global macro at Fidelity Investments, argues that market conditions are favourable and could push the index a little higher and generate modest gains for investors. “From 2009 to 2015, the market was ripping higher, by almost 20% a year. Then it was in a holding pattern for a year and a half, stuck in a range between 1,800 and 2,130 points on the S&P 500, with lots of small moves in between,” says Timmer. Keywords Fund managers center_img Today the S&P 500 Index is at about 2,140 points, a level that has not been driven by earnings growth but rather by strong liquidity conditions. Typically, Timmer observes, the Federal Reserve would be guiding markets toward further rate hikes, but then there would be a shock, such as the Chinese devaluing their currency, and that would force the market down. “The Fed would respond to that by saying, ‘We’re going to have fewer hikes, or no hike at all.’” The Fed’s stance created a more favourable liquidity backdrop. Financial conditions improved, the U.S. dollar dropped slightly and markets would go back up again, says Timmer. “Every rally within that trading range was driven by improving financial conditions, and not by improving earnings growth. That’s been against a backdrop of full valuations of 18 times earnings, which is about where the market should be.” The turning point came last June, in the wake of the Brexit referendum on the United Kingdom voting to leave the European Union, when the Fed backtracked on raising rates once again, and triggered a world-wide decline in bond yields. In some cases, sovereign bond yields turned negative, and even the benchmark 10-year U.S. Treasury yield of 1.5% was almost neck-and-neck with inflation. “This was the key that drove the market to new highs,” observes Timmer, noting that the market rebound was driven by a group of defensive high-dividend paying stocks that were scooped up by yield-hungry investors. “This ‘breakout’ was a liquidity-driven move. There is an insatiable search for yield around the world. And the U.S. is not in bad shape as the economy is chugging along. But there is this global tide of lower yields and it’s driving U.S. yields down, too.” Still, Timmer argues that there are so-called “green shoots” of earnings growth that are supporting the U.S. market. “Earnings growth is still falling and around -2%, year-over-year for the second quarter. But we all know at certain inflection points the market tends to focus more on the rate of change than on the level of earnings,” says Timmer. “We have had five quarters of negative earnings growth,” he says. “That’s significant; it’s like an earnings recession. But the worst point was in the first quarter when earnings fell 7%, year over year. In fact, you had a sequence of worsening rates of change. Yet in the second quarter the rate of change improved dramatically, from -7% to -2.3%.” Beneath the surface, “things are getting less bad,” argues Timmer. “That’s an important momentum shift on the earnings side. And it is something the market is also responding to. These two moves are pushing the market upwards: we have improving liquidity, driving dividend-paying stocks higher and dragging the market with it, and earnings growth is starting to get a little better, at least on a rate-of-change basis.” Assuming that earnings do come through, as the market is expecting, then price-earnings multiples will decline somewhat and valuations will become less stretched. “If you look at current price over earnings and if the rate of change is going to improve, then that earnings number will go up and the price-earnings multiple will catch up to that.” Looking at the market, Timmer notes that industrial, energy and materials stocks are the most visible winners in the earnings game, as they have benefited from stabilizing oil and metal prices and a weaker greenback that has lifted profits for multinational companies. “It’s the most economically sensitive sectors which have benefited.” Timmer admits there is a risk that earnings may stay sluggish for some time. “I don’t have any sense that annual earnings growth will go back to 5% or 6%, as they have done historically. So we may still be in a low-earnings growth of 1% to 2%. Yet that’s an improvement over -1%. And when things start to get less bad, the market starts to respond to that.” Timmer does not have excessive expectations for the S&P 500 Index. “The market may just grind higher. I don’t think we’re going back to the days of 2009-2015 when the market rose 20% a year. It’s going to be a grind higher, based on this ongoing combination of favourable financial conditions and slightly better earnings growth,” says Timmer, adding that over the next few years total returns from the U.S. market might be in the mid-single digits in local terms. One concern Timmer has is that the quality of earnings is poor because about 70% of earnings are generated through share buybacks. “It’s a poor quality and low-growth earnings environment,” he says. “That is not a recipe for a runaway bull market.” Facebook LinkedIn Twitter Share this article and your comments with peers on social media Related newslast_img

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