U.S. equity prices have stopped falling over the next last couple of days, but global growth headwinds will constrain the profit outlook. We retain our cautious bias.
The recent drop in equity prices was sparked by weaker than expected growth in Europe, the steep decline in inflation expectations on the back of U.S. dollar strength, and the perception that policymakers are not doing enough collectively to support the global recovery. Negative global economic surprises amidst the downdraft in oil prices have undermined confidence in the sustainability of the global expansion, triggering a reset in the equity risk premium.
Typically, equity valuations and inflation expectations move hand in hand. But a gap opened at the onset of the latest QE program. Now that the latter is ending, valuations are recoupling with inflation expectations.
Eventually, lower oil prices should boost economic activity, but without more stimulative fiscal and monetary policy, growth outside of the U.S. will remain in doubt. In particular, evidence of some traction in euro area economic activity likely is needed to sustainably reverse the slide in inflation expectations, and by extension, fears of a profit slump.
On Europe, we continue to expect that results of the ECB’s stress tests at the end of the month, as well as easing in fiscal austerity, could brighten prospects – please see the next Insight, Euro Area: Potential For Upside Surprise?