Compiled by Cai Haoxiang
EQUITY STRATEGY 2018
JP Morgan Cazenove, Dec 4
Equities had a strong run in 2017, with MSCI World delivering 21 per cent total returns so far year to date, to be by far the best performing asset class.
Looking into next year, it seems more and more tempting to turn bearish given the strong outperformance, significant price to earnings rerating, the likely peaking in activity momentum and an upcoming turn in liquidity conditions.
However, we believe the positives still outweigh the negatives, and stay "overweight" equities into 2018.
Growth momentum might have peaked, but activity is still likely to remain above trend. Earnings are likely to show further robust improvement.
With a 2 per cent eurozone real gross domestic product growth projection, 10 per cent earnings per share (EPS) growth looks reasonable.
This might make 2018 the second year in a row without EPS disappointments.
Central bank tightening is still in its early stages, with US real policy rates outright negative at present.
None of the last eight downturns started with real rates below 2 per cent. Furthermore, any inflation pickup would act to reduce real rates further.
Yield curve is unlikely to invert until at least the second half, 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 the Fed will persevere with hikes.
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 300 basis points valuation gap, and this is just to get to the fair value.
Regionally, we believe emerging markets will consolidate versus developed markets entering 2018, post the strong run.
This is partly predicated on JP Morgan expectations of four Fed hikes next year, versus markets pricing in less than two, and the US dollar being supported, at least in H1 2018, as well as a large tech weight.
We are overweight Japan for 2018, as the only region where the central bank will keep providing support.
Globally, one should consider a more sustained reversal in the underperformance of value-financials (overweight) versus growth-tech (neutral).
Defensives (underweight) are unlikely to lead if yields move higher, but earnings of euro utilities (overweight) are turning up.
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