Mea culpa! We failed to pick a further slide in interest rates and missed out on our own model’s S&P 500 valuation last month, which was 2,993 points with a 30-year at 2.65%. This long rate actually fell further than that, hitting 2.50% to give us a year-end objective of 3,043 points. Our hypothesis was a rise to 3% against a backdrop of calmer US-China trade relations; the truce negotiated at the G20 summit will give the Federal Reserve a welcome respite. The inverted US yield curve out to 3 years highlights the gap between market expectations and the real intentions of a Fed that needs to take account of the financial bubble created by low rates and an inflation rate that is no longer that tame. Equities would correct by 10% if Fed policy pushes the 30-year rate towards the 3% mark. Eurozone yields have tracked America, but as the ECB can hardly lower its own rates any further the euro has strengthened.
Slumping yields have prompted investors to search out assets with some assurance of cash flow: real estate in all forms and listed shares backed by concessions on motorways or airports. Vinci is a good example – and every European country has an equivalent. Vinci almost got hold of ADP, too. Aircraft manufacturers with substantial order books are another option. Dividends are a source of cash flow in themselves and have proved resilient over a long period.
Despite the trade war, forecasts for world growth this year are unchanged at 2.9%, with Asia-Pacific driving most of it. Germany is suffering from weaker export performance and has seen its growth forecast lowered to 0.8%; France is stable at 1.3%. Italy is verging on recession. The prospects for the US economy are perhaps not as bright as the forecasters think, as the PMIs have turned down sharply towards the key 50 mark. US corporate earnings will be virtually unchanged after an exceptional 2018, mainly because electronics components firms such as Micron are casualties in the trade war against China. We expect EPS to rebound 9% in 2020. Eurozone earnings estimates are being shaded lower yet again and we cannot see growth of more than 3% this year. European markets can boast those nuggets with predictable cash flows, however.
Our annual review of the energy sector underlines a strong 2.9% increase in consumption in 2018, although that for oil was up just 1.2%. Renewables are still posting remarkable growth: an average 15% per year, including 33% for solar energy. BP is playing down the sector’s outlook but its own forecasts have doubled from where they were five years ago. We believe the share of renewables in the overall energy mix to rise to 9.1% by 2025 and 14.1% by 2030, thanks notably to solar power. Proven reserves of oil and gas have fallen sharply, reflecting the fact of oil prices below 0 per barrel in recent years. Given that demand is not about to evaporate, prices could spike at some point, and that would heighten the search for substitutes even more. Given negative interest rates, the shrewd thing to do might be to keep oil underground until that happens…
Low interest rates are good for our market valuations but the gap between what the markets expect and what the Fed needs to do may prevent them staying low for much longer. Liquid investors should invest to earn at least something on their assets. We are underweighting our benchmark (35% versus 40%) until we see what happens to interest rates and the trade war.