Equity markets, macro indicators playing tug of war

Heading into 2020, institutional investors are eyeing the disconnect between gloomy macroeconomic indicators and strong equity market performance.

Leading indications in both North American and European economies have been trending down all year, with global gross domestic product growth forecasts in a slump, said Alec Young, managing director of global markets research at FTSE Russell, during a webinar on Dec. 11.

However, there’s a silver lining, he said. With the exception of the 2008 financial crisis, leading indicators haven’t fallen much below their current levels in the past 20 years, which suggests, from a technical perspective, this could be the bottom for negative sentiment. “There’s a possibility, based on history, that numbers will start to exceed low expectations. And, in fact, we are seeing that.”

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The optimism stems from an easing of financial conditions, said Young. Early in 2019, the U.S. Federal Reserve pivoted away from its tightening cycle, which unleashed a fair bit of risk appetite. “They thought that perhaps they’d overdone it and trade was a bigger global macroeconomic risk than they’d thought and they had to reverse course.”

A number of other global central banks have joined the Fed in making rate cuts, expanding this easier economic environment.

In the year ahead, the most serious challenge expected to dampen that optimism is earning risk, said Young. In the U.S., earnings over the past year haven’t been spectacular, but outlooks are setting them in the double digits for 2020. “This seems overly optimistic,” he noted, adding analysts have a historic tendency to overestimate earnings potential. “Analysts are often right on the direction of profits, but they’re wrong on the magnitude.”

It makes more sense for investors to expect more modest earnings growth and then be pleasantly surprised if companies exceed their expectations, he said.

Read: Global institutional investors sober as markets rally: survey