March 23, 2017
The world economy will grow steadily over the next two years and that means investors should stay invested in equities, according to Barclays Capital Plc.
The bank’s analysts presented several major themes for the next two years: President Donald Trump and Republicans in Congress will enact some kind of stimulus plan as the 2018 mid-term election looms for lawmakers, European stocks are undervalued compared with U.S. stocks and deflation risks have ebbed globally.
“There will be tax cuts in the U.S., both corporate and personal,” said Ajay Rajadhyaska, co-head of global fixed income, currencies and commodities research at Barclays, in a call with reporters.
He said investors have asked him whether the Trump agenda was in doubt after stocks on Tuesday had their worst day since before the election as the Republican plan to overhaul Obamacare met strong opposition from a conservative wing of the party. Investors fretted that Trump’s failure to get healthcare reform through Congress may embolden opponents to his plans to cut taxes and reduce regulation.
Negotiations between the conservative House Freedom Caucus, which wants a complete repeal of Obamacare, and Trump have been ongoing since Speaker of the House Paul Ryan, R-Wisc., introduced the bill last week. The vote had been scheduled for Thursday, but was later delayed.
“The Trump administration’s decision to focus first on health care legislation, rather than tax policy, has caused us to push our forecast trade and fiscal policy initiatives back to early 2018 and to reduce the magnitude of the assumed fiscal expansion,” Rajadhyaksha said in a report. “The risks associated with this new policy scenario lie not in the revised economic outlook, but in the possibility that investors could become anxious that tax reform will be derailed by political setbacks.”
Delays to U.S. fiscal stimulus led Barclays to cut its forecast for economic growth from 2.5 percent to 2.2 percent for 2018.
“If investors lose confidence that the Republican administration and Congress can deliver tax cuts, we would expect a negative market reaction,” Rajadhyaksha said, “but it seems unlikely that investors will price in any such political stalemate for several months; the Trump administration has made it clear that a fiscal package is likely only toward the end of 2017.”
Better Value in Europe
Barclays said European stocks are a better value than U.S. equities, especially since the bank doesn’t expect political disruptions as French elections loom. European stocks have a 12-month forward price-to-earnings multiple of 15 times, compared with 18 times for U.S. equities.
“Earnings are starting to perk up in Europe,” according to Barclays. “For the first time since 2010, a broad range of European stocks is receiving upgrades to earnings estimates.”
That’s not to say investors should abandon U.S. stocks even though they have gotten more expensive since the November 8 election. The S&P 500 trades at a 12-month trailing multiple of about 20 times adjusted earnings with a short-lived collapse in energy industry profits inflating trailing price-to-earnings ratios slightly.
“Global equities are not at such frothy valuations that they create an independent market risk of their own,” Barclays said. “We expect financial markets to remain risk supportive in the absence of a material economic or political disappointment. This will eventually happen, but we do not think it will be in the calendar quarter or two immediately ahead.”
Deflation Less Worrisome
Since the financial crisis of 2008, central banks globally have loosened credit as a way to combat deflation. Monetary policymakers see deflation as a sign of economic weakness.
“Shrinking output gaps and firmer commodity prices continue to be reflected gradually in core inflation,” Rajadhyaksha said. “But with wage pressures slow to develop, the risk of a market-unfriendly inflationary outbreak appears very low.”
The bank forecasts that the global economy will grow 3.7 percent this year and 3.8 percent in 2018.
“While unimpressive by historical standards, this forecast is meaningfully firmer than in 2016, in both advanced and emerging economies,” according to Barclays. “This global improvement has been helped by the upswing in producer prices stemming from the stabilization of commodities in 2016.”