Via Morgan Stanley today:
Morgan Stanley’s outlook for US Equities has been lifted, with ~15% upside to a 2700 SPX target. We think Australia will not follow a late-cycle push in the US, given domestic growth headwinds offsetting the pulse of global reflation and earnings. Stay focused on Materials, Global Earners and revisit Quality.
USA Equities – 15% Upside: Mike Wilson, Chief Investment Officer of Morgan Stanley’s Global Wealth Management business has assumed coverage of US equity strategy,and launches with a 2,700 S&P 500 target (see US Equity Strategy: Initiation of Coverage: Classic Late Cycle, 10 Apr 2017). The global cyclical upswing of 2016 and synchronised growth into 2017 are embedded in his team’s view that the market is entering a classic ‘late-cycle’ phase as animal spirits finally reawaken.
Better US Earnings: Underpinning this optimism, S&P 500 earnings are expected to grow by around 10% yoy in 1Q17, with revenue growth accelerating to ~8% yoy in 1Q17. This is the healthiest top-line seen in the US since 2012, reflecting stronger US and global nominal growth (see Global Macro Chart Board: Reflation Picks Up Pace,24 Feb 2017).Looking ahead, the team’s proprietary earnings indicator for the US flags further upside to consensus over the next 6-9 months, with 12-month forward EPS by August expected to lift to $142(see Exhibit 5).
Higher US Multiples: More controversially, our new US equity outlook factors multiple expansion,as still-cautious positioning and sentiment continue to migrate towards the ‘euphoria’ investment phase. Their 2,700 target assumes the 12m forward PE lifts from 18x to 19x, consistent with the US Equity Risk Premium tightening towards its historical average of 240bp,even as US 10yr yields rise to our 3Q17 forecast of 2.75%. This is much less pronounced for Australia where even factoring in the strong EPS recovery in MSCI Australia, the ERP is 5.4% versus its post-98 average of 5.2%.
Australian Leverage? There is a clear correlation between the US market performance and the Australian benchmark which is understandable give the US’ influence on both DM equity valuations and risk sentiment more generally. With respect to valuation, the ASX 200 has traded at an average discount of 10% to the S&P 500 since 1992, but we see a deeper discount to emerge as cycle risks similar to those priced in 2003-04 emerge linked to housing and unemployment. With this economic outlook in the base case – a 25% discount to the US multiple would not be out of the question for the ASX 200. On this basis, we think some late-cycle S&P 500 multiple expansion is already factored into current ASX 200.
Given Australia Lacking a Cycle: While the US economy and market may be seeing a boost as the headwinds of regulation and deleveraging turn to tailwinds, we think Australia continues to lag the global reflation. We explore this challenge for domestic policymakers, where record-low wages growth and record-high gearing are leaving the RBA in a very difficult position (see Australia Macro+ and AxJ FX/Rates Strategy: The RBA’s Rock and a Hard Place; On Hold Until 2019, 7 Apr 2017) – and now signs of this being priced with a recent reversal in rates markets from hikes to some chance of a cut in the last two days. We think the implication of a constrained policy rate, behind-the-curve fiscal policy, and more MacroPru is lower credit growth, weaker wages and consumption and ultimately less earnings growth.
Stay Focused – Prefer Materials, Global Earnings and Quality: It is tempting to chase momentum in the world’s largest equity market, and get on board with more constructive MS views on major DM markets including Europe and Japan. However, the domestic cycle disconnect keeps us focused on playing the global themes driving positive earnings momentum, whilst insuring against a domestic slowdown. Materials and Energy still offer upside to the synchronised recovery; Global Earners with valid growth pipelines offer stronger outlooks with an FX tailwind,and we also recommend revisiting Quality and Growth
I completely agree. In fact, MS is underestimating the forthcoming under-performance because it is far too bullish on iron ore which, as it tumbles in the months ahead, will kick the Australian economy right in the income guts all over again. Having said that, Australia’s few global earning industrials remain a good bet, as MS says.
That’s where the pilot for the MB Fund (launching next month) has its underweight Australian equity allocation versus 60% offshore.
Register your interest today (if you have not already).
