With no support from Trump, global mkts look to monetary policy, earnings for cues

Anubhav SahuMoneycontrol Research

Global markets had cheered the US election outcome with a rally which hasn't reversed yet. Given Donald Trump's policy missteps, one would have imagined that the markets would fall. As the political upheavals left no mark, it is perhaps time to pay heed to more fundamental factors like earnings and macro developments.

The upcoming event calendar is chock-a-block with global central bank meetings ahead of the Federal Reserve’s symposium in Jackson Hole (August, 2017). Quarterly earnings season is also picking up steam.

In the backdrop of increasingly low visibility on Trump’s policy actions, equity markets are surprisingly at new highs. We take a look at global cues to assess where we stand.

Global central banks: dichotomy of low inflation and improving economy

As central banks tread a cautious path of normalisation of monetary policy, soft prices are forcing a rethink.

This morning BoJ (Bank of Japan), as expected, kept its monetary stimulus programme unchanged but postponed the deadline for achieving 2 percent inflation rate to April 2019 (earlier April 2018). While this underlines the difficult task for Governor Kuroda to quickly get past the deflationary phase, this is also in contrast to the approach adopted by other central banks, who, in recent past, have been hinting at moving away from stimulus. Yen weakened and gains in Asian equities were the immediate reactions.

Later today, markets would also look up to Mario Draghi’s comments in the ECB policy meet. Recently, ECB affirmed that there is a broadening of recovery in the Euro area. Deflationary worries, at the same time, have died out and the current softness in inflation is seen as transitory. Euro/USD has reacted to such signals from the central bank with a surge of about 10 percent since April 2017.

Fed: Balance sheet unwinding can take precedence this time

Federal Reserve, however, has been signaling continuing monetary policy normalization. However, tools for monetary tightening may shift from rate hikes to balance sheet unwinding in the near-term. Recent speech from Lael Brainard, member of Fed’s board of governors, suggests that Fed’s balance sheet unwinding can start as early as September.

Brainard opined that real neutral rate (fed funds rate minus inflation) is near zero implying rates are neither stimulating nor restraining the economy. This also suggests that the Fed can possibly hold back its rate hike decision in the near-term. This opinion in conjunction with Yellen’s testimony to Congress suggests that the Fed might wait for more data (particularly inflation) to take a call on rate hike. Market participants now largely expect the next rate in the December meeting.

Having said that, monetary policy normalisation remains on course unless there is a large error creeping in the policy models from inflation forecast.

US earnings season: good start but mixed bag from financials

Q2 2017 US corporate earnings have commenced on a positive note. Out of the S&P companies, 6 percent have reported earnings so far and 80 percent of the companies that have reported, have posted earnings ahead of expectations which is slightly higher than the long term average of about 77 percent.

Amongst sectors, technology/media, materials fared well. Netflix reported net addition of 5.2 million subscribers ahead of estimates. Alcoa forecasted an increase in global demand for aluminum (median 5 percent in 2017 vs 4.75 percent earlier). Financials, however, struggled. Fixed income trading revenues were lower for all the major banks, with major weakness seen in Goldman Sachs (-40 percent YoY).

Fading visibility on Trump’s execution

While cues from the earnings season help to judge corporate health amid higher interest and wage cost, it also helps to gauge corporate guidance in light of fading Trump’s policy execution.

An interesting insight from Factset mentions that there is a significant reduction in mention of “Trump” in the earnings conference calls in Q2 2017. It clearly indicates that Trump’s administration/policy references are increasingly finding less attention in the corporate calls.

An excerpt from the transcript of Accenture underlines the increasing frustration of corporates, “…The fact of the matter is that would – I would say this to be honest, three months ago, because just reading the observers and all the analyses, we believe that these four reforms (the healthcare reform, the tax reform, the trade reform, infrastructure) would happen reasonably rapidly in the US. And, fact of the matter, they are not yet being announced or executed, and so we are in this zone where the business is still waiting..”

Should equity investors worry at this juncture?

Weak visibility in the legislative approval and execution of Trump policies can potentially de-rate US equities. However what, partially, comes to rescue for US equities is the traction in US corporate earnings. US earnings sentiments (analyst upgrades – downgrades) have improved to ~4 percent (vs global earnings sentiments) of 2 percent recently.

Nevertheless, US policy uncertainty remains high and in the backdrop of elevated valuations, caution is warranted.

For the Indian investors, a short-term risk-off phase is not ruled out which could emanate from portfolio outflows. However, improving global macro data supports the case for lower risk of a contagion.

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