In a recent blog post by BlackRock’s Global Chief Investment Strategist Richard Turnill, he explains the decision to upgrade their view of U.S. stocks and shift down to neutral on European equities. While we admire the strategists at BlackRock and other industry pundits who share this view, we respectfully disagree.
The main argument Mr. Turnill brings to the table for the upgrade is higher U.S. earnings growth momentum, as evidenced by a sharp acceleration in analyst earnings upgrades. He reasons that this trend—underpinned by strong fundamentals coming from robust economic growth and fiscal stimulus—will fuel equity-market returns going forward. And since the U.S. is displaying the strongest acceleration and Europe the weakest, he upgrades the former and downgrades the latter.
Cause for celebration or cause for concern?
Now, it is undeniable that U.S. earnings growth has been strong and that equity analysts have revised up their expectations significantly. But in our opinion, this is more cause for concern than celebration. If we take a closer look at the chart of the week in the blog post—and we show Mr. Turnill’s smoothed earnings revision ratio and add the unsmoothed ratio, as well as more history—it becomes clear just how extreme this past upgrade cycle has been. In fact, in the second chart below, we can see that in the past two months, earnings expectations for 2018 have been revised up from 12% to 19.7% growth. To upgrade an equity region after such a cycle, knowing that the hurdle for positive earnings surprises has just increased tremendously, runs counter to our beliefs. Especially since the revisions ratio does not have a great track record as a leading indicator of equity-market returns.
Source: Thomson Reuters Datastream, 02/09/2018
Source: Thomson Reuters Datastream, 02/12/2018. I/B/E/S: Institutional Brokers’ Estimate System
We also struggle with Mr. Turnill’s assessment of the fundamentals and valuation. Although the total amount of U.S. fiscal stimulus is significant, it does not come without a cost. In a country without much spare capacity, an unfunded fiscal boost to economic growth will increase inflation, not to mention the budget deficit. This has already caused rates to move higher, with expectations closing in on three U.S. Federal Reserve (the Fed) rate hikes in 2018. Mr. Turnill mentions the risk this poses to valuation multiples but fails to mention how much of the returns in U.S. equity markets over the past three years can be attributed to them.
Leave A Comment