Outlook now clearer for global markets after US Federal Reserve meeting

At last the Federal Reserve’s meeting is finally behind us.

The Fed’s move not to hike rates and the economic projections showed that the Federal Open Market Committee has lowered its expectations for growth in the near term and long run.

It expects that unemployment should continue to trend lower and that although it will take some additional time, inflation will head towards the 2 per cent target rate, impacting the rate path lower.

The Fed feels it is not under time pressure yet, and indeed there is still labour slack in the US economy: the ratio of the employment workforce to population has barely recovered, as there seem to be a lot of jobless and underemployed people.

Furthermore, the committee acknowledged that global pressures weighed on its decision.

We believe that while the market will have a tougher time looking at what drives the Fed decision from now on (economic forecasts are better and yet there was no hike, while global conditions have been mentioned as an influencing factor for the first time), a potential rate hike in December gives enough time for the Fed and the market to confirm that China’s macroeconomic and market wobbles are unlikely to derail the domestic recovery.

Finally, the dollar has weakened following the Fed meeting. The sharp dollar move is likely to weigh meaningfully on export-linked sectors, and by some estimates it is equivalent to a 50 to 100 basis points tightening of the Fed’s policy rate. Therefore in a way, China has already done some of the Fed’s tightening job.

In conclusion, the Fed is watching four variables: domestic inflation, domestic growth, financial conditions and global growth. Between now and December there is potential for financial conditions to improve, should China stabilise its foreign exchange reserves. In the meantime, volatility in the markets will tick higher, as investors need central banks to restore confidence for market valuation multiples to hold.

Meanwhile, the end of summer has been eventful; the reverberations of the Chinese central bank’s move to allow the weakening of the yuan has moved markets globally.

Volatility has spiked across many asset classes, especially in developed market equities.

In terms of markets implications, rather than bottom-fishing in an emerging markets universe which may be subject to ongoing pressure and an extended commodity super-cycle demise, developed markets are looking more interesting the more they sell off.

The economic recoveries in the United States, Europe and Japan are slow, and at about 2 per cent GDP growth, they are unlikely to be seriously derailed by what is happening in Asia. Cheaper Chinese goods, lower commodity prices and the related benefits for developed market consumers should stabilise growth conditions in the US and Europe in the months ahead.

US housing markets are recovering, and rising labour incomes should start to benefit consumption more than we have seen this year. Another bit of good news on developed markets: in Japan, earnings beat consensus estimates by 11 per cent, marking the 11th quarter in a row during which consensus estimates were exceeded.

We do not believe the US and Europe are facing recession. It is important to stress that within the developed markets equity space, our highest conviction remains in domestic growth.

As a start, the healthcare and technology sectors are still benefiting from a very strong secular backdrop.

For other sectors, it’s a cyclical tailwind story. Consumer spending is supported by solid employment growth, better credit availability, lower interest rates and cheaper energy.

In this space, we are looking for valuations that are cheap enough to match the realities of a slower growth world, one with high profit margins but low growth in top-line sales and earnings. That is particularly after adjusting for the fact that earnings are already boosted inorganically by stock buybacks (2015 is a record high), mergers and acquisitions and other forms of financial engineering.

In addition, the earnings of multinational companies exposed to emerging markets will be under pressure: the globalisation of S&P earnings since the mid-1990s, which had been a huge tailwind, is becoming a headwind.

In fact, single-digit returns and higher volatility are what we should expect from developed markets equities over the next couple of years.

Cesar Perez is the global head of investment strategy at JP Morgan Private Bank.

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