Key global trends – equities finally pull back
Global equities had their first monthly negative return since bottoming in March, reflecting a shakeout in the high-flying U.S. technology sector. Despite the risk-off equity sentiment, gold prices also fell back (and commodities more generally), which likely reflected a rebound in the ‘safe-haven’ $US. Already very low global bond yields hardly budged either way.
Despite these ‘counter-trend’ moves in September, as seen in the chart set below, global bond yields and the $US remain in a medium-term downtrend, with global equities and gold prices in an uptrend*.
Global equity fundamentals – valuations reliant on low bond yields, earnings expectations have lifted
Let me offer a couple of new charts this month – breaking down the key fundamental drivers of the most important equity index in the world, the S&P 500.
As seen in the first chart below, the S&P 500 ended September trading at a price-to-forward earnings (PE) ratio of of 21.3 – which is a bit lower than the levels seen in recent months, due to both the correction in prices and a modest lift in forward earnings. As evident, 21.3 is well above its long-run average level but to an extent reflective of the very low level of bond yields – with the U.S. 10-year government bond yield ending the month at only 0.7%.
Econometrically drawing a ‘line of best fit’ through the monthly levels of interest and PE valuations stretching back several decades (granted a crude valuation metric), suggests a PE ‘fair value’ at end-September of 19.9, or 7% below the actual level. Given the loose relationship evident in the chart, however, this degree of valuation is not that extreme – and somewhat less stretched than at end-August.
My second chart focuses on U.S. earnings expectations. It tracks analyst expectations for calendar year earnings and hence forward earnings estimates on a rolling monthly basis.
Note: ‘forward earnings’ is a weighted average of current and subsequent calendar year estimates – with the weight on next year’s earnings rising as it gets closer. In essence, for example, forward earnings in June 2020 reflect a weight of 50% to CY’20 and CY’21 earnings respectively. In December this year, forward earnings will place a 100% weight on CY’21 earnings (wherever analyst expectations are at the time).
The chart below shows that while earnings expectations were downgraded significantly earlier this year (reflecting the economic lockdowns) they have since stabilised, and in fact increased a little. Based on current market expectations, U.S. forward earnings are on track to rise by 23% between now and end-2021, which (at end-September prices) would pull down the PE ratio to a more reasonable 17.3. Even allowing for moderate further downgrades (my estimates in the table below) could still see forward earnings rise by 14% over this period, with the market trading at an end-2021 PE ratio of 18.7.
All up, this analysis suggests the U.S. market could hold up if the economic recovery continues and bond yields stay reasonably low – but significant further upside could be limited, given the prospect of some eventual lift in bond yields and an already fully valued market.
Key global equity themes – U.S., technology, growth and quality
As seen in the table below, it was the popular U.S., technology and growth/momentum themes that suffered the biggest pullbacks in September, though financial, energy and ‘value’ stocks more broadly also had notable declines. Being only the first month of a potential ‘counter-trend’ equity rotation, the relative performance rankings of the long popular U.S., technology and growth/momentum themes remain in place.
Tables ordered by 6/12 month return performance for each region, sector and factor respectively – on a local currency basis. Past performance is not indicative of future performance. You cannot invest directly in an index.
As seen in the table below, these trends are reflected in the performance of BetaShares’ thematic global and Australian equity ETFs.
Within Australian equities, technology (ATEC), resources (QRE) and financials (QFN) had notable declines, while real assets (RINC) held up best. Technology, resources and small caps (SMLL) remain the top three relative performers.
Among the global currency-hedged funds***, both growth and value-related exposures suffered declines, ranging from the worst performer FUEL (not helped by the drop in oil prices) to financials (BNKS), gold miners (MNRS) and the tech heavy NASDAQ-100 (HNDQ). Other recent strong performers that held up well, however, include global quality (HQLT) and health care (DRUG).
Smaller declines were generally evident among unhedged global equity funds, reflecting weakness in the $A. India (IIND), Asian technology (ASIA) and robotics and artificial intelligence (RBTZ) enjoyed solid gains. In general the technology themes – and to a lesser degree emerging markets (EMMG) – retain the strongest relative performance rankings.
Tables ordered by 6/12 month return performance for each region, sector and factor respectively. Past performance is not indicative of future performance of the index or fund. You cannot invest directly in an index. Index performance doesn’t take into account any fund fees and costs.
Cash and bonds – government yields drop, credit spreads widen
In the local cash and fixed income market, overall bond yields fell last month while credit spreads widened – resulting in fixed-rate bonds outperforming cash, and government bonds doing better than corporate bonds (of similar duration).
Source: Bloomberg. Past performance is not indicative of future performance. You cannot invest directly in an index.
More broadly, however, the BetaShares long-duration corporate bond fund (CRED) and long-duration government bond fund (AGVT) have tended to outperform the Australian fixed-income benchmark in recent months, reflecting the continued grind lower in bond yields. Still-contained credit spreads also continued to support the performance of hybrids (HBRD) and floating-rate bonds (QPON) over cash (AAA).
Source: Bloomberg. Past performance is not indicative of future performance of the index or fund. You cannot invest directly in an index. Index performance doesn’t take into account any fund fees and costs.
*Trend: Outright trend is up if the relevant NAV return index is above its 12-month moving average and the slope of the moving average is positive, and down if the index is below this moving average and the slope of the moving average is negative. No trend is displayed in all other cases. Relative trend is based on the ratio of the relevant return index to its broader Australian or global benchmark index.
**The ranking of performance is based on an equally-weighted average of 6 & 12 month return performance.
***Where both currency-hedged and unhedged global equity funds are available, the analysis focuses only on the currency-hedged fund performance.