* The directional call…liquidity and growth
In the US, financial conditions are tightening. The corporate’s sector’s utilisation of debt
is soaring as the financing gap deteriorates. And the corporate debt maturity calendar
looks onerous in 2016. The risk is spreads move materially higher again. Given the
reliance on debt funded buybacks this has direct, and negative, equity market
implications.
In EM, the debate over whether there is a mini-cycle forming may continue near term.
But the structural issues are not improving. Corporate debt lies at the root of the
problem. The NPL cycle is only just beginning. And in China we have real concern on
the Banks’ capital resilience. Impaired financial intermediation points to sustained
pressures on domestic liquidity and, by extension, growth. Equity negative.
For once, Europe offers a stronger story. A central bank that stands ready to escalate
monetary policy support, and a domestic economy that is showing some momentum.
For us, it is the one major region where macro conditions look supportive of equity
markets. This should favour domestic stocks and underpin a relative trade. But we
suspect that global influences are likely to weigh on the aggregate indices.
Valuations are clearly elevated. Considering the capital structure, rather than just the
equity, and European ratings have only been higher through the TMT bubble. The
European CAPE is often mis-used – remove the structurally changed sectors and the
rating is again at the top of the range. But perhaps the greatest mis-perception relates
to dividends. Yields may look attractive against credit, but capex is extremely
depressed and payout ratios close to historic highs. Even in a benign world, as these
factors normalise, future dividend growth will materially lag earnings. Buying equities
requires investors to stomach rather than embrace valuation.