Executive summary

Equities have rallied on better global growth and expectations for the Trump administration’s economic stimulus in the U.S. market. We worry that expectations are running ahead of reality.

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Alternative facts

Donald Trump promised to “make America great again” during the presidential campaign, and equity markets have taken him at his word. The S&P 500® Index is up 12% since his election in early November through March 17, 2017. But in the same way that inauguration crowd sizes are open to dispute, the strength of market fundamentals can also be debated.

Market bulls see reflation and investor confidence. We’re a bit more cautious due to very expensive U.S. equity market valuation, high profit margins and an economy unlikely to sustain the current surge. We’re not bearish on the medium-term outlook; the U.S. economy shows relatively low recession risk and Europe can maintain above-trend growth, while emerging markets are showing resilience to U.S. dollar (USD) strength and U.S. Federal Reserve (the Fed) tightening. But equity markets to us look overconfident about the prospects for sustainably higher profit growth and at risk of disappointment.

Paul Eitelman questions investor optimism about the U.S. economy, preferring to label the outlook “resilient but mediocre.” He thinks the Fed will tighten once more this year and that most of the rise in Treasury yields is in the rearview mirror.

Wouter Sturkenboom remains positive about the outlook for Europe. Political risk is much lower than feared, and he sees plenty of spare capacity in the economy. Inflation is being pushed higher by transitory factors, and he believes rising inflation will therefore be ignored by the European Central Bank (ECB), which likely will continue with very accommodative policy settings.

Regarding the Asia-Pacific region, Graham Harman reports it continues to display resilience. Japan’s economy remains lackluster, China is balancing slightly better growth against rising interest rates, and both Australia and New Zealand are in reasonable shape. He expects low returns and high volatility across the region.

The U.S. dollar still has some limited upside potential, in Van Luu’s view. Widening interest rate differentials give the USD an advantage, but this is tempered by expensive valuation. He believes the wild card is the potential for a new U.S. border tax system. However, he thinks that the tax is unlikely, and if implemented, would be less USD bullish than many analysts predict.

The business cycle index model estimated by Kara Ng and Abe Robison shows that recession risks for the U.S. have declined slightly over the past quarter. Their models for U.S. equities versus fixed income continue to show a neutral outlook.

The U.S. equity market hasn’t been “made great again,” and we believe investors’ optimistic expectations are in danger of disappointment. Equally, investors are underplaying the genuine improvements underway in Europe. Alternative equity market facts should eventually give way to actual outcomes.

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