The Japanese equity market has been among the weakest ones in the year to date. At -15% (as of 12 July 2016; source: Bloomberg), the Nikkei index is one of the worst performers. For euro investors, the bottom line is not as abysmal: adjusting the loss for the development of the Japanese yen vis-à-vis the euro, the performance improves to -4% (Bloomberg). In spite of the negative sign, the net result still outperforms European equities.
Shares (equities) are classified, among other criteria, according to sectors, e.g. healthcare, consumer goods, energy etc. Shareholders pursue different approaches when it comes to the classification process. In this report we follow the methodology of MSCI, a US financial service provider that offers international equity indices and risk analyses.
Everybody who has read academic literature on the performance of shares will know about the fact that value shares (and small cap shares) outperform so-called growth shares in the long run.
The international stock exchanges recorded a rather dismal start into the new year. The reasons cited most frequently were China and the declining oil price. A weaker Chinese economy will definitely register also on an international scale due to the mere size of the country. While a weaker oil price is beneficial to consumers, it does cause significant levels of stress in the energy sector as well as among banks that provide credit to the sector.
A factor that has hitherto been more or less disregarded is the general earnings situation of listed companies. Therefore we want to take a closer look at this topic in this article. Without earnings growth, there can be no sustainable rise in share prices.
Earnings cycle has peaked out
In the developed markets equity universe the earnings cycle peaked out in February 2015. Since then, earnings have been on a slow but steady decline.
The stock exchanges have been moving sideways and down for weeks. There are of course enough uncertainty factors such as the Greek crisis, the correction on the Chinese stock exchange, and the expected interest rate increase in the USA that can serve as explanation. However, one factor that has (so far) been left out of the equation is the fact that company earnings are hardly growing. The increase on stock exchanges is fundamentally justified if the valuation levels are rising across the board without earnings growth (e.g. price rises due to the low interest rates) or if company earnings themselves are rising (thus justifying the valuations). The interest rates can actually not fall any further, which means that the stock exchanges cannot get any impulse from that end.
How does the other factor, earnings growth, look? There is no clear answer to that question. Some market participants are rather sceptical. In the following I will try to shed some light on these factors, company earnings and earnings momentum.
We have seen European equities outperform their American peers in the year to date, both in local currency and in euro. Not even the increase of the US dollar relative to the euro of 8% made a difference to that. What is this pro-European optimism based on? After all, the US economy has seen a significantly better development than the Eurozone. The same is true for US companies, which have been recording profit growth, as opposed to Europe, where profits have generally been falling recently. The uncertainties in Greece and Ukraine only add to this scenario.