JPMorgan Stays Overweight Equities into 2018

Here are the key reasons provided by JPMorgan’s strategists  Mislav Matejka, Emmanuel Cau, Prabhav Bhadani and Aditi Balachandar in a note dated Dec 4:

« 1) Growth momentum might have peaked, but activity is still likely to remain above trend. Earnings are likely to show further robust improvement . With 2% Eurozone real GDP growth projection, 10% EPS growth looks reasonable. This might make ’18 the second year in a row without EPS disappointments .

2) Central bank tightening is still in early stages , with US real policy rate outright negative at present. None of the last 8 downturns started with real rates below 2%. Furthermore, any inflation pickup would act to reduce real rates further. Yield curve is unlikely to invert until at least 2H, and crucially, stocks never peaked before the yield curve would get outright inverted . Finally, if equities were to roll over, we find it very unlikely that Fed will persevere with hikes – the central bank put is still in place.

3) Granted, equity multiples do not look cheap in absolute terms, but relative to both bonds and to credit, we find equities continue to offer an almost 300bp valuation gap, and this is just to get to the fair value.

Equities score the best when we consider prospective total returns for ’18 that other assets offer:  according to JPM, Euro HY credit should deliver +1%, HG credit -1%, Euro Bonds -2% and cash -0.4%. Hardly inspiring, in our view. »

As a reminder, JPMorgan expects global real GDP growth to be 3.2% in 2018, with US at 2.2%, Eurozone at 2.1%, Japan at 1.4%, UK at 1.6% and China and EM at 6.5% and 4.5% respectively.

Earnings should be a key driver for markets, with 2018 « could be a second year in a row where earnings do not see downgrades. »

Consensus (IBES) expects EPS to grow 9% in Europe next year (thanks to IT, Financials and Industrials), 11.8% in the US (with Energy, Materials, Financials, IT), 12.7% in EM (with Healthcare, Discretionary and IT in the driving seat). Japan should be much slower at +3.1% (due to a -11.3% drag in Industrials).

One of the key questions next year will be the potential impact of the tax reform in the US on listed companies. Here are some simulation ran by JPMorgan:

Valuation is not going to play a major role in equities return, since P/E multiple are not cheap on a global basis. But valuation is relatively more attractive than other asset classes.

Key risks to this rather optimistic scenario: « growth disappointment lead by US recession, Credit dislocation in HY or in China, Eurozone politics and too abrupt bond repricing. »

Overall, JPMorgan expects 7% return for European equities (MSCI Europe) and 5% for UK equities (FTSE 100). Underlying assumptions for Europe are 7% EPS growth next year, P/E multiple of 15x which puts the MSCI Europe at 1,720 points end-2018.

In terms of regions, JPMorgan is Overweight Eurozone, and Japan, Neutral EM and US, Underweight UK and RoW.

 

Global/European Equities: Where is The Consensus ?

2 useful tables from Deutsche Bank that give a view on fundamental trends and valuation ratios for several market places + a deep dive into European markets (geographies/sectors/size).

 

Source: Deutsche Bank
Source: Deutsche Bank

 

UBS Sees Stoxx Europe 600 at 440 Points End-2018

Per Nick Nelson’s report date Nov 13:

« We recalibrate our top-down earnings model as it had been persistently underestimating the turn in operational leverage. We now see 10% EPS growth in 2018. Consensus estimates are 8.9%, but adjusting for the average upward bias, underlying « true » consensus may be as low as c.2%. We see modest P/E re-rating to 15.7x from 15.0x currently. For the FTSE 100, we are more conservative and target 7,900 end-2018 (c.6% upside). »

« Upside risks: Equities re-rate to previous cycle peak valuations. This would point to c.33% upside from the current levels. European corporates re-gear to US levels. US investors return (net buying peaked in May). European M&A picks up, currently running c.30% below the US. Effective French labour market reform. »

« Downside Risks: Rates and bond yields rise too sharply. But a gradual move would likely be manageable – Europe has very little Tech (6% of index) and a large amount of positively rate sensitive Financials (c.25% of index). Significant Euro strength, on our forecasts (EUR/USD 1.25 end 2018) this is manageable. Higher volatility / political risks in Spain and Italy. »