DR.CHENJIAZI ZHONG

Macro Update

On U.S.  

U.S. real GDP increased at an annual rate of 2.9%[1] in the third quarter of 2016, as compared to the 1.4%[2] increase rate in the second quarter. The latest U.S. inflation rate is 1.5%[3] through the 12 months ended September 2016, as published on October 18, 2016; the rate could give the Fed confidence that inflation is to reach the bank’s 2% target. Real disposable personal income increased 2.2%[4] in the third quarter, as compared to an increase of 2.1%[5] in the second quarter. Despite a slowdown in consumer spending, the U.S. economy is growing at a faster-than-expected pace, largely supported by the surge in exports and the rebound in inventory investment.

The S&P 500 Index declined -1.94% in October of 2016; it has been in a holding pattern since June. As of Oct 28, 2016, among the 58% of the companies in the S&P 500 reporting earnings for the third quarter 2016, 74%[6] of S&P 500 companies have reported earnings above the mean estimate and 58%[7] of S&P 500 companies have reported sales above the mean estimate. For the third quarter 2016, the blended earnings growth rate for the S&P 500 is 1.6%[8]; if the index reports growth in earnings for the quarter, it will mark the first time the index has seen growth year over year in earnings since the first quarter of 2015, which was up 0.5%[9].

Monetary and fiscal policy should support economic expansion, but political uncertainty may dampen capital expenditure (capex). The forward 12-month P/E ratio for the S&P 500 is 16.4[10], which is above the 5-year average (14.9)[11] and the 10-year average (14.3)[12]. Valuations remain elevated, while forward-looking guidance on margins and profitability remains weak, which is putting downward pressure on investment spending.

U.S. Companies Profit Margins

As of September 30, 2016

Historical analysis suggests that markets tend to favor incumbent candidates in the months leading up to presidential elections, likely because they represent less uncertainty to investors. Political uncertainty in the U.S. gives companies more reason to hold off on investment.

On Eurozone

The eurozone economy showed renewed signs of life at the start of the fourth quarter, enjoying its strongest expansion so far this year. The Markit Flash Eurozone PMI rose to 53.7[13] in October 2016 from 52.6[14] in September, signalling the fastest monthly increase in business activity since December of 2015. The PMI is consistent with its GDP growth rate, which was up 0.4% in the third quarter.

Policymakers will be encouraged by signs of both stronger economic growth and rising price pressures. While much of the rise in prices in October could be traced to higher oil and energy prices during the month, the increased incidence of supply chain delays suggest that pricing power is being re-established. If this continues, the shift from a buyers’ to a sellers’ market should in theory push core inflation higher – a welcome development for which scant signs have been evident in recent years.

The October survey saw an especially encouraging recovery in German growth, with the PMI pointing to a 0.5%[15] pace of expansion and the rate of employment growth climbing to a five-year peak. German PMI, Ifo Business Climate Index, and Gfk Consumer Confidence are consistent with the ZEW data released earlier this month which has been saying Germany is poised for a “Golden Autumn”.

Modest growth of 0.2-0.3% is being signalled for France, but there are various indicators which suggest that France will enjoy stronger growth in coming months, including a marked build-up of uncompleted work and a resurgent export growth, both of which rose at the fastest rates for over five years.

On U.K.

U.K. real GDP slowed to 0.5% in the third quarter of 2016 rom 0.7% in the second quarter. New UK Prime Minister Theresa May announced that Britain would begin the process of leaving the EU by the end of March 2017, which removed some of the uncertainty about how the country would extricate itself from the EU but had also heightened concerns about the potential ramifications of a hard Brexit. The continuing market uncertainty, however, will provide opportunities for patient long-term investors.

[1] Bureau of Economic Analysis

[2] Bureau of Economic Analysis

[3] Bureau of Labor Statistics

[4] Bureau of Economic Analysis

[5] Bureau of Economic Analysis

[6] FactSet Earnings Insight by FactSet Research Systems Inc., October 28, 2016

[7] FactSet Earnings Insight by FactSet Research Systems Inc., October 28, 2016

[8] FactSet Earnings Insight by FactSet Research Systems Inc., October 28, 2016

[9] FactSet Earnings Insight by FactSet Research Systems Inc., October 28, 2016

[10] Bloomberg

[11] Bloomberg

[12] Bloomberg

[13] IHS Markit

[14] IHS Markit

[15] HIS Markit