As 2018 draws to a close, strong US corporate cash flow has been well-supported by tax cuts and increasing fiscal spending. This may continue to underpin reasonably healthy capital expenditures and support economic growth and earnings delivery in the US — but the big question is, will growth pick up around the world?
The big picture: Earnings and valuations Earnings
In late 2018, key regions outside the US have seen a softening in gross domestic product expectations, industrial production and purchasing manager indices. There are many moving parts here: higher oil prices, higher US interest rates on dollar-denominated debt, weaker currencies, trade tensions undermining confidence, etc. And yet, despite the soft patch in some of these macro indicators, there is a broad expectation that all major regions around the world (with exception of Japan) may deliver high-single-digit to low-double digit earnings growth in 2019.¹ The region that stands out the most is the eurozone, with consensus expectations for earnings growth to pick up from about 6% this year to 10% next year.² On the other hand, expectations are for US earnings growth to decelerate from more than 20% this year to about 10% next year.²
Despite the stock market sell off in early October, we believe equity valuations remain vulnerable to higher bond yields and discount rates, particularly among the technology names. US stocks continue to trade at a premium to non-US stocks, a fact which many have come to dismiss given relative earnings progression of the past several years. And yet, non-US markets indices have been trading at discounts on earnings and book multiples not seen in 15 years, with emerging markets (EM) discounts pushing to new extremes in late 2018 and the International Monetary Fund downgrading growth in many EM markets. Yet, specific names are starting to look appealing to long-term investors like ourselves.
1 Source: FactSet Estimates, as of Oct. 15, 2018
2 Sources: FactSet Estimates, MSCI, as of Oct. 15, 2018. Non-US stocks represented by the MSCI EAFE Index, US stocks by the S&P 500 Index, and emerging markets stocks by the MSCI Emerging Markets Index.