! We reduce our EPS growth forecasts for 2011 to 12% (from 14%) in the US and 7% (from 12%) in the Euro-area (6% for both in 2012) and take our 2011 year-end target for the S&P down to 1,350 from 1,450 previously (1,400 for end-2012), on the back of weaker than expected growth. Yet, we stay overweight equities (having upgraded on June 14th at slightly higher levels), due to:
! Modest growth reacceleration. We believe US GDP growth will recover to circa 2%, from 1.1% in 1H, given that monetary policy is still very loose; healthy US corporate balance sheets, strong FCF and under-investment make us expect 5% capex growth; our models are consistent with 1.5-2% US consumption growth and housing is very cheap. None of the normal preconditions of a US recession are in place. Yet, we continue to believe in a sub-trend developed market recovery because of $6trn of excess leverage. Critically, global growth is helped by the fact that GEM is now half of global GDP (and we believe that China will have a soft landing, although we think Indian and Brazilian growth needs to slow further).
! Relative valuation looks compelling: the ERP on consensus earnings numbers is 6.8% - and even on post-1920 trend earnings it is still 5%, while ISM/credit spreads suggest 4.7% is warranted. Over the last week, real bond yields have fallen (ie lower discount rate), inflation expectations have risen (with equities being an inflation hedge as long as inflation remains below 4%). Tactical indicators are mostly supportive, in our view .
! Two big risks: 1) Europe: key changes in principle occurred two weeks ago, but we think the ECB/EFSF has to start buying Spanish and Italian bonds before markets are calmed; 2) US fiscal tightening will be 2.5% of 2012E GDP if payroll tax credits are not renewed.
! We believe the end game is negative real rates (across the yield curve), alleviating debt service burdens and forcing investors to take on risk, reducing the saving ratio and revaluing GEM currencies. We think QE in the UK and Japan looks likely; we attribute a 50% chance of more QE in the US.
! Key investment themes: GEM consumer (luxury cars, luxury goods), index-linked bond proxies, defensive cyclicals (software); and quality growth. We continue to stay underweight of cyclicals.
! Modest growth reacceleration. We believe US GDP growth will recover to circa 2%, from 1.1% in 1H, given that monetary policy is still very loose; healthy US corporate balance sheets, strong FCF and under-investment make us expect 5% capex growth; our models are consistent with 1.5-2% US consumption growth and housing is very cheap. None of the normal preconditions of a US recession are in place. Yet, we continue to believe in a sub-trend developed market recovery because of $6trn of excess leverage. Critically, global growth is helped by the fact that GEM is now half of global GDP (and we believe that China will have a soft landing, although we think Indian and Brazilian growth needs to slow further).
! Relative valuation looks compelling: the ERP on consensus earnings numbers is 6.8% - and even on post-1920 trend earnings it is still 5%, while ISM/credit spreads suggest 4.7% is warranted. Over the last week, real bond yields have fallen (ie lower discount rate), inflation expectations have risen (with equities being an inflation hedge as long as inflation remains below 4%). Tactical indicators are mostly supportive, in our view .
! Two big risks: 1) Europe: key changes in principle occurred two weeks ago, but we think the ECB/EFSF has to start buying Spanish and Italian bonds before markets are calmed; 2) US fiscal tightening will be 2.5% of 2012E GDP if payroll tax credits are not renewed.
! We believe the end game is negative real rates (across the yield curve), alleviating debt service burdens and forcing investors to take on risk, reducing the saving ratio and revaluing GEM currencies. We think QE in the UK and Japan looks likely; we attribute a 50% chance of more QE in the US.
! Key investment themes: GEM consumer (luxury cars, luxury goods), index-linked bond proxies, defensive cyclicals (software); and quality growth. We continue to stay underweight of cyclicals.
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