Equity bull run: will the upswing live to celebrate its ninth birthday?

The US administration’s recent actions have proved unsuccessful. We do not expect any plans of relevance to tax reform and infrastructure measures to emerge before the summer, leading us to expect a period of quiet surrounding President Trump and hoped-for gifts for the stock markets. A typical US stock has nevertheless rarely traded as expensively as today. This makes corporate earnings growth an urgent necessity, as otherwise the risk of a sharp setback exists.

There can be no talk of a bubble forming in the equity market here in Germany. Stock markets worldwide have reached a high level in terms of the past decade’s average price-earnings ratio (PER) and price to book ratio (PBR). The absolute levels are nevertheless relatively low, especially in Europe. In Germany, the PER for the DAX stands at 13.5 for 2017e and 12.4 for 2018e. Plenty of headroom remains up to the valuation level marking the high point of the Internet bubble in 2000, when the PER of Germany’s lead index ascended to above 35.

One of the following three causes have always ended past equity market bull runs: bursting of an equity market bubble (approximately every 40 years, e.g. the automotive bubble at the end of the 1920s, „Tronics“ bubble in the early 60s, dotcom bubble in 2000), oil price shock (1973/74 and 1979), economic recession combined with sharp increases in key interest rates (including in 2000/01 and 2007). Among these reasons, the greatest risk factor to end the current equity cycle would be a sharp increase in long-term interest rates. Nevertheless, equity markets do not start to correct until the last interest rate increase in the cycle, and in the USA the Fed has only just started its new cycle of interest rate hikes. We do not see the high point in US fed funds rates until 2019 (and even then only at 2.5%), and not until 2021 in Europe (at 1.5%). At the same time, we take a positive view of 2017/18 global economic growth prospects. The chances are very good that the equity bull market will live to celebrate its ninth birthday.

There appears little probability, however, that the past months‘ good share price performance will continue in the near future. Until the next elections in Europe (France in April), the chances are that equity markets will consolidate. After the end of the reporting season, a period of weak news flow begins. The Trump rally in the USA has also given up a lot of its dynamism after recent setbacks. A consolidation phase would be very welcome as earnings estimates have recently failed to keep pace with share price rises.

Our conclusion: investments in the DAX, emerging markets and dividend strategies are recommended for new investments during and after the consolidation.


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