Economic surprise accelerating

The positive economic surprise data seen over the last 3m continues to strengthen. If anything, the data is moving faster than any monetary tightening leading to a benign environment for risk assets such as equities. What is more of a conundrum is the lack of response in global bond yields, even as the final developed market central bank to move, the Bank of Japan, is now hinting that it is past peak monetary accommodation. Earnings forecasts for 2017 remain robust with median growth close to 10% for developed markets and a similar level of growth forecast for 2018.

Furthermore, the surge in economic surprise is not seasonal and therefore suggests a real improvement in economic conditions. The data series may in fact be supported over the next two months by the strong tendency of December and January to deliver positive economic surprises compared to the rest of the year.

Exhibit 1: Positive economic surprise accelerating

Developed market earnings forecasts for 2017 have remained relatively stable in the second half of 2017, given that the modest declines in Europe ex-UK are largely a result of the appreciating euro, which has risen by 8% on a trade-weighted basis since Q2. The resilience of earnings estimates has been an important short-term support for markets, even if positive economic surprises have yet to feed into the data. Looking forward into 2018, the current consensus calls for a further 10% increase in profits for developed markets. We would not over-rely on this figure however, as forecasts are in general revised lower over time. The actual out-turn for 2018 will only become clearer by mid-year.

Exhibit 2: Earnings estimates stable during H2

In hindsight we have been over-cautious in our strategic views during 2017 as the performance of both Europe ex-UK and US markets have been relatively strong, despite the starting point of extended valuation multiples and progressively tighter monetary policy in the US at least. It is has also become increasingly evident that the digital economy is consolidating around a handful of global leaders which has led to an exceptional and not unwarranted performance of the US tech sector during 2017. At present and as we have previously noted, it is difficult to see the potential for sharp declines in equity markets in the short-term given the currently positive economic backdrop and still resilient profits growth expectations.