Eurozone growth was weaker in the first quarter, but there is no reason it should completely stall. Export orders remain well oriented, lending conditions are still favourable and business investment is continuously improving. With oil prices stabilising around USD 75, GDP should increase by 2.3% in 2018, slightly below the 2017 figure. In this environment, the ECB is likley, by the end of the year, to stop buying bonds, but will nevertheless keep a very accommodative stance, especially if Italian perspectives remain uncertain.
In the United States, despite a small dip at the start of the year, growth remains solid. Business investment has made a clear turnaround, while consumption – still the main driver of the economy – is supported by dynamic job creations. The rebound in retail sales observed in April underscored the fleeting nature of the weak Q1 performance. While the tax reform should have a limited impact, the spending increases voted into the 2018 budget will have a greater effect on growth. If geopolitical uncertainties and trade tensions do not affect sentiment, US growth should come out near 3% in 2018. To fend off any risk of an “inflation panic”, the Fed will forge ahead with policy normalisation, implementing three more rate hikes this year.
Growth cycle & Liquidity
The economic cycle is becoming more mature and thus the expansion is becoming less synchronised. In the Eurozone, negative surprises nevertheless appear to have bottomed out.
Monetary tightening is progressive and has started in the US. The Fed, which hiked interest rates once again in June towards the 1.75-2% range, will continue to tighten into, and towards the end of, 2018. Financial conditions remain nevertheless supportive. In the meantime, inflation is gradually approaching the Fed’s 2% target. This way, the Fed’s tolerance to inflation overshooting is likely to be tested in the coming months.
Meanwhile, the European Central Bank has announced the continuation of its QE tapering, reducing monthly asset purchases to EUR 15 billion as from October (from EUR 30 billion now). The central bank will have brought to a halt its asset purchase programme by the end of the year, but will not hike interest rates before the second half of 2019.
Earnings & Valuation
Earnings remain a clear supportive factor for equity investors after a strong US (24% growth year-on-year) and decent European (10% growth year-on-year) earnings season in the first quarter of the year. We expect US earnings to continue to display double-digit growth, while European earnings should progress around 10% in line with economic growth. Meanwhile, valuations look relatively appealing and expected returns are clearly in favour of equities versus bonds.
Investor sentiment has now become less cautious, with investors worried mainly about a potential trade war and monetary policy divergences. Around 40% of the investors questioned by the BofAML Fund Manager Survey believe the equity market will peak in 2019 or beyond.
The global cross-asset scenario remains in favour of equities. The global expansion is self-sustained and not easy to derail, while global equities are supported by solid earnings growth, especially in the US. Valuations are less stretched than at the beginning of the year. The main risk to our scenario is the fact that markets are switching between two ‘opposing risks’: inflation fears and recession fears. Also, the peaking macro momentum, intensifying protectionism, reappearance of political risk within the EU, and the oil price evolution remain important attention points.