Fundamentals Are Becoming Important Again to the Trump-Led Stock Market

The market's rallying as analysts upgrade their expectations -- a rarer event than you might think.
Photographer: Martin Leissl/Bloomberg

The president who hates experts is helping to make their opinions count again. 

That's the implication of recent data from Citigroup Inc., which show that analyst opinion is moving emphatically in the same way as the stock market once more, after a long period when equities' persistent gains seemed to be thwarting fundamental analysis. 

Earnings revisions worldwide rose last week by 10 percent compared to the seven days before, led by the U.S. and Japan. The double-digit jump outpaced the previous week's 7 percent rise, which itself was the sharpest set of weekly upgrades since May 2011, according to Citi's earnings-revision index, or ERI, which is compiled weekly using the MSCI Inc.’s All-Country World Index

That's happened as a slew of different stock markets rallied to new highs — which is not, on the face of it, a shock. It ought to figure that stocks rise when analysts say they will: "Traditionally, ERI has been a coincident indicator with stock prices," analysts at the U.S. bank, led by Robert Buckland, wrote in a note last week.

Yet in recent years, analysts have more often than not been caught out by the direction of the market. The relationship "seemed to break down from 2012-15 when global equities rose, despite analyst downgrades," according to Buckland and team. 

Despite softening profit projections, global stocks jumped in that period as buybacks and central-bank stimulus diminished the role of company and industry-specific news as a driver. The S&P 500 added an average of 13 percent in each of those four years, defying dire prognostications.

Low dispersion in company earnings and a rising degree of correlation between equities and bonds transformed the market for U.S. large-cap stocks into an effective punt on macro — and especially monetary — tailwinds, a Goldman Sachs Group Inc. report lamented in October.

Now, there's good news for active managers and stock pickers: prices are rising along with profit projections.

A Trump-triggered regime shift for global equity markets has triggered analysts to hike profit projections for growth interest-rate sensitive sectors at the expense of defensive stocks, while yen and euro weakness against the dollar have buoyed earnings expectations in Japan and continental Europe.

Citi chart
Source: Citigroup Inc

It's a testament to the extent to which monetary stimulus has upended conventional market dynamics that the re-emergence of an intuitive relationship in equity markets — stocks valuations should, after all, reflect the discounted value of future cash flows — is a noteworthy development for the Citi analysts. 

It remains to be seen whether the Trump-led regime shift sweeping global markets will normalize a bevy of other unconventional dynamics weighing on equity markets including valuations propping up a clutch of U.S. stocks thanks to debt-financed buybacks despite meager earnings growth, and investors largely shrugging off record U.S. corporate leverage

With optimism back in vogue, stocks have a high bar to clear next year, the Citi analysts conclude, alluding to the market's earnings-per-share (EPS) projections. "Consensus analyst forecast of 12 percent 2017 global EPS growth looks high compared to the last few years’ outcome. However, continued dollar strength and future tax cuts in the U.S. could make this achievable."

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