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Equity: Focus on earnings season

October 26, 2018

Overall assessment

In the US, after a period during which equity market returns have been driven by top quintile stocks based on price/earnings (P/E) and beta, we have seen strong rotation. The top quantile P/E stocks (mainly tech) underperformed the most during the recent market selloff, while stocks with lower valuations in more defensive sectors started to outperform. We have been calling for this rotation and believe it will continue. Seeking quality stocks trading at appealing valuations will, in our view, be the way to navigate this phase of rotation and higher volatility. On a regional perspective, we think it is time to maintain a high level of diversification. Europe continues to face short-term challenges due to the Italian budget situation while EM are still vulnerable in this phase of uncertainty. Hence, we remain cautious on these areas while we recognise that they should both offer better opportunities once some risks dissipate (Italian budget and pre-midterm election tariffs rhetoric in the US).



Europe

Strong rotations occurred recently in European equities, favouring defensives and value. Yet, we think it is too early to call for a full market rotation to value, though we believe it is wise to keep a neutral sector allocation perspective and focus on a selection of companies within each sector that can deliver sustainable EPS growth and keep up with market expectations. As the cycle ages, the market becomes more tilted towards punishing companies that miss market expectations vs rewarding companies that beat estimates. This is key, especially in the banking sector which remains exposed to multiple risks, including the Italian situation, Brexit and EM stories.

United States

Markets will be very vigilant over the current earning seasons in order to assess the impact of tariffs and a strong dollar on US corporations. Company margins are likely reaching a cyclical peak, given the progressive rise of input costs, including wages. This is usually a sign of the maturity of a cycle, but we expect earnings growth to continue in 2019 (IBES forecasts at 10%). In our view, rising interest rates and, more recently, trade issues will continue to push volatility higher. With this outlook in mind, we think that it is wise to maintain a conservative allocation and avoid over-stretched areas (most expensive growth names) that can suffer the most in what we see as a correction within an uptrend. At the sector level, we would seek opportunities in capital goods, banks and telecoms, while we are cautious on the most stretched areas of technology.

Emerging markets

EM equities remain under pressure amid fragile market sentiment. Yet, within this broad universe, we continue to see some interesting themes. One is the ‘long oil’ theme to take advantage of the trend of rising oil prices due to the upcoming disruption of the supply from Iran when the US embargo becomes effective in November. On this theme, we like Russia, given the low valuations and already discounted effects of US sanctions. We also see opportunities in China, especially in the technology and energy sectors. On the opposite side, we are cautious on Chile, being sensitive to the copper price, and on Turkey, due to political risk.
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Beta. A statistical measurement of an investment’s sensitivity (volatility) to market movements in relation to an index; for example, a beta of 1.2 suggests 20% more volatility in returns than the benchmark, which is assigned a beta of 1.0.

 

 

Important Information

 

Diversification does not guarantee a profit or protect against a loss. 

 

Unless otherwise stated, all information contained in this document is from Amundi Pioneer Asset Management (“Amundi Pioneer”) and is as of October 30, 2018.

 

The views expressed regarding market and economic trends are those of the authors and not necessarily Amundi Pioneer, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Pioneer product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.

This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service.

 

Date of First Use: October 30, 2018.

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With volatility trending higher, it is time to focus on valuations and stocks able to deliver sustainable earnings growth.

Contributing Authors

Kenneth J. Taubes

CIO of US Investment Management 

 

Yerlan Syzdykov

Head of Emerging Markets 

 

Alexandre Drabowicz

Deputy Head of Equity