Heading into 2018, investors were cautiously optimistic and for good reason: a majority of countries around the globe were benefiting from rising confidence indicators, falling unemployment and synchronised growth. Encouragingly, this positive macroeconomic backdrop was filtering down to the corporate level. In the UK, for example, analysts began the year forecasting 7% 2018 earnings growth for the FTSE All-Share.
January began much as December had ended, with a sustained rally sweeping across global markets. By mid-January the rise had been so meteoric over the preceding 1.5 months that to carry on at that rate would have implied an annualised performance of 57% for the All-Share.
Despite the positive newsflow at the corporate level, clearly the market’s rise was a case of too much too fast. Mutterings and questions of when markets might be due a correction began to gather pace and sceptics became more vocal with the market on edge. And so it turned out that an accelerated rise in bond yields and inflation expectations combined with a spike in volatility was enough to see an adjustment in the markets.
Inevitably the correction was swift, broad based and largely indiscriminate as investors unwound positions following a prolonged period of low volatility. In a time of rising rates, focus shifts to the balance sheet, but with the average All-Share company operating at c1.5x leverage one could easily argue that this isn’t a concerning statistic.
In situations like this, when you are faced with a sea of red on your stock screens and a market sell-off which one could argue is both rational and irrational at the same time, it often helps to take a step back and try to put things into context. As investors, it’s often easy to let your emotions run away with you and focus too much on where the stock market has come from, extrapolating the trend. In contrast, our behavioural finance process is designed to strip out the emotion from investing and focus on the facts.
So what are the facts?
The FTSE All Share is now down 5.5% year to date. At its worst point in the correction, the index broke levels not seen since February 2017—and yet since then the underlying stocks that constitute the FTSE All-Share have delivered 20% earnings growth. In 2018, earnings growth is forecast to continue its positive trajectory with analysts expecting earnings to rise 7%, and the global economy is growing at its fastest pace in seven years. Furthermore, 90% of markets are now growing above trend. At the half way stage of the Q4 reporting season UK companies have on average surprised positively on both sales and earnings, with 60% of companies exceeding expectations. From a valuation perspective, the FTSE All-Share is now trading at its cheapest levels at any point in the last two years, with the market on 13.1x forward PE versus a long-run average of 14.1x. Jump across the pond and you’ll find the S&P trading on 15.7x. The data is out there to support a recovery.
By all means the UK still faces a number of challenges in 2018 and beyond with some tough decisions on Brexit still to be made and deals to be worked through. Undoubtedly politics will impact short-term market sentiment in either direction. That said, often investors can be guilty of overstating the link between domestic economic prospects and the location of a stock listing, extrapolating this link to guide their expected share price performance. However, that is a dangerous exercise and nowhere is it more dangerous than in the UK, where companies that make up the FTSE All Share derive approximately 70% of earnings from overseas. The UK equity markets are therefore not simply a signal of the UK’s economic health: they provide much broader exposure than that.
In the short term, the equity market may take a pause for breath after an action packed period and search for a catalyst to move things on. But from where I’m sitting the underlying fundamentals appear to remain intact.
Blake Crawford is the manager of the JPM UK Dynamic Fund. Read more >
Unless otherwise stated, all data is sourced Bloomberg as at 15 February 2018.