Week ending 19th January 2018.

US equity indices continued to make new highs this week.

While journalists love to talk about extended valuations and over-priced equities, I believe they are painting a misleading picture. The US equity market has not become irrational – and silly comparisons with 1987 or the 1999 dot-com boom are just that: silly.

In fact, the fundamentals for this rally are strong: not only is global growth looking robust, but US equities are also benefitting from Donald Trump’s massive tax cuts coupled with bullish outlooks accompanying the current fourth-quarter earnings seasons.

The US tax cuts are transformational and will give a massive boost to the US equity market’s earnings-per-share. For example, this week UnitedHealth raised its adjusted profit projection to $12.30-$12.60 per share in 2018, up from an initial forecast for $10.55-$10.85 due to the tax reforms, while Citigroup said that the tax reforms will strengthen their capital generation capabilities and committed to the return of at least $60bn to shareholders. Apple said it will repatriate hundreds of billions of US dollars currently held abroad and invest in US manufacturing and data centres.

Additionally, a number of companies such as AT&T, Comcast, Fifth Third Bancorp, Wal-Mart and Wells Fargo have announced plans to give employees a $1,000 bonus and/or a pay-rise. This will put more money into the pockets of US consumers, potentially creating a virtuous circle (a simple return of confidence).

So far, we have barely scratched the surface of earnings season (only 10% of the S&P 500 companies have so far reported), but if the rest are anything like those that have already reported, earnings estimates and stock prices are arguably too low.

And it isn’t just US equities that will benefit from the tax reforms. The ECB’s December policy meeting minutes released last week stated that the US tax cuts “might have a greater than expected impact on economic growth” and that their impact “had only partially been taken into account in the December staff projections”, suggesting that the ECB may upwardly revise its GDP growth projections.

Furthermore, China this week said that GDP increased to 6.8% in Q4 from a year earlier. As a result, full-year growth picked up to 6.9% from 6.7% in 2016 – its first full-year acceleration since 2010 which underpins global growth.

While I am not complacent and appreciate that there are always plenty of risks (and the obvious ones are a long-term US government shutdown if politicians can’t agree a funding deal; or a potential policy error by the Central Banks by removing monetary stimulus too quickly), I don’t believe this is the time to be exiting equity markets, and instead believe it is better to remain fully invested and enjoy the ride from the rising economic tide.

Elsewhere, this week’s UK CPI inflation data showed that inflation is finally slowing down as the Brexit impact starts to fall out. CPI fell back to 3% in December from 3.1% in November.

Interestingly, looking at the sector breakdown on a month-on-month basis, discretionary items (such as Clothing & Footwear; Restaurants & Hotels) fell the most, while the big gainers were the areas that consumers can’t do without (such as Food; Household Costs; and Transport). Consequently, this will squeeze many households further – suggesting that we may see further cautious trading statements from retailers and leisure companies as consumers are forced to choose between essential and discretionary purchases.

This data makes it obvious that our inflation is predominately being imported (due to a weak pound since the Brexit vote) rather than being domestically generated. And with contracting real incomes set to continue its drag on UK economic growth in 2018, my misgivings regarding the BoE’s recent interest rate increase have intensified – which only strengthens my conviction that the BoE is unlikely to increase interest rates again anytime soon.

In fact today’s (Friday 19 January 2018) UK retail sales data showed the consumers spent 1.5% less in December than November (the biggest month-on-month decline in 18 months) – and while sales for 2017 as a whole gained 1.9%, this was the lowest annual growth in 4 years.

In Germany this Sunday (21 January 2018), the SPD will hold a special party conference on whether to proceed to official coalition discussions with Angela Merkel’s CDU. While it seems that the SPD rank-and-file aren’t that enthralled with another coalition, there appears to be a growing acceptance that a coalition with the CDUs is the best way to renew their party after a disappointing election result last September. So while it isn’t a resounding endorsement, it is likely to be enough to keep Angela Merkel in power.

Additionally we have UK & US Q4 GDP; US & Eurozone PMI data; UK employment data; and an ECB monetary policy meeting.

Ian Copelin, Investment Director

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