Thematic Report

Just a relief rally or will earnings follow?

by Desh Peramunetilleke / Feb 22, 2019

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Global equities have started the year on a positive note in the hope of a potential US-China trade deal and a dovish Fed. Indeed, Asian equities are up 11% since the market bottom at the start of year, making it the second relief rally within the broader downcycle that started a year ago. Given the underperformance by well-held sectors such as consumer and tech last year, investors are concerned about missing out on these shorter market cycles. However, if history is any guide, the current rally is on its last legs, while earnings downgrades remain significantly negative amid less compelling valuation support after the rally.

Lifecycle of relief rallies
We firmly believe the current market upcycle is only a relief rally given the potential earnings downgrades that are yet to come. As mentioned in our What’s in style for 2019 report, we prefer a barbell approach through quality and yield. We are also of the view that markets do not enter a sustainable upcycle when earnings growth is flat. In this context, we analysed the 12 Asian relief rallies since 2000. Data suggest that on average such rallies last for six weeks with a return of 12.9%. In comparison, the current rally has continued for seven weeks with a return of 11%, suggesting that we are already close to the historical averages. Also, in line with history, we find that China and Korea are outperforming during this rally. Within sectors, tech remains the leader despite the downgrades.

Earnings downgrades still accelerating
Another valid concern among investors is whether the markets are moving ahead of an imminent earnings bottom. In our What’s in style for 2019 report we forecast -0.9% earnings growth for 2019 compared to 7.6% by consensus. An update of the data for January 2019 shows that downgrades have continued to accelerate. We expect earnings downgrade to continue at least until 3Q19, but catalyst for upgrades remain elusive given the weak macro conditions. For investors looking to time the markets, we find that any sustainable recovery usually starts 2.5 months before earnings bottom. Also, the earnings bottom is led by a turnaround in momentum for tech, non-bank financials and industrials, all of which remain weak.

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