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| Deflation strategies |
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Have markets reached a turning point? |
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Trying to pinpoint the absolute bottom of an investment market is always challenging, however Citi analysts have identified six key factors that can offer insights into where equity markets are likely to head, and whether a turning point is imminent |
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It could still be too early to suggest equity markets have reached their lowest point as many of the issues that plagued markets in 2008 are still with us, nonetheless markets can still experience significant rallies under current conditions |
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While a more sustained rebound is taking far longer than many investors would like, Citi analysts believe the global policy response is helping to create the conditions essential to an upswing, and investors may wish to use the current market weakness to upgrade their portfolios, building positions in quality companies that generate strong cashflow and possess above-average growth prospects. |
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With this in mind, let's take a look at the six factors that Citi analysts believe can offer a guide to the equity market's current position. |
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| Factor 1: Corporate Earnings Downgrades |
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The Institutional Brokers' Estimate System (IBES), which monitors the earnings estimates of 18,000 companies in 60 countries, suggests global corporate earnings growth are expected to fall by -8% in 2009 |
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While this 8% decline is an improvement from the -21% drop experienced in 2008, Citi analysts believe the figure is still too optimistic, and estimate it could fall to around -30% |
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The fall in global demand raises the risks of subsequent downward revisions, and Citi analysts don't expect corporate earnings to reach a bottom point before early 2010. |
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| Chart 1: Earnings Revisions and MSCI AC World (Rebased to 100) |
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| Source: CIRA, Bloomberg. As of 4 March 2009 |
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| Factor 2: Falling Interest Rates |
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Falling interest rates and accommodative policy are precursors to recovery |
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Policy, which has been active over the last 18 months, has gone into overdrive over the last six months, with rates in the US, UK and Switzerland now close to zero, and central banks also employing Quantitative Easing (QE). |
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| Chart 2: Policy Rates US, Eurozone, UK and Switzerland 1980 – 2009 |
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| Source: DataStream. As of 26 March 2009 |
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| Factor 3: Inflation |
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Citi economists expect inflation to all but disappear from most of the developed world over the next six months. On some measures, the US and Japan are already showing deflation |
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Over the past 100 years, the turn of big bear markets and the start of new bull markets have coincided with a normalisation of inflation - either the end of deflation or the end of inflation |
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The deflationary trend needs to be turned to help call the market bottom, and to date, this is not happening. |
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| Chart 3: US Inflation 1881 - 2009 |
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Note: Data point for 2009 is CIRA estimate.
Source: CIRA, Global Financial Data and DataStream. As of 26 March 2009 |
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| Factor 4: Weak Economic Growth Forecasts |
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Economic growth and inflation forecasts from both Citi economists and external organisations such as the International Monetary Fund (IMF) continue to fall, with little sign of a bottoming out of growth expectations for 2009 |
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Citi's economists have trimmed back their 2009 expectations for global GDP growth from -1.5% to -2.1%. They expect the global economic slump to persist through the third quarter of 2009 but believe the effects of policy stimulus and improved financial conditions should provide a lift later this year. |
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| Chart 4: Global Dividend Yield Versus Cash and Government Bond Yields |
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| Source: OECD, Bloomberg, Citi Economic & Market Analysis. As of 5 March 2009 |
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| Factor 5: Weak Business Sentiments |
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Data from both the US ISM manufacturing index (which measures the health of the manufacturing sector) and the German IFO business climate survey continue to point to poor conditions. In most of the sub elements of the ISM survey, the data remains negative, and while the ‘new orders’ component has stopped falling, it remains in contraction territory. Additionally, US durable goods orders turned positive in February. There is no sign that the OECD composite lead indicator is getting worse, so despite some signs of an upswing in certain data, conditions are definitely still recessionary |
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The Baltic Dry Freight, a main indicator for commodity-freight rates, rallied sharply but has given back some of those gains recently. The Manpower Hiring Survey, which measures employers’ hiring intentions, generally offers a good guide of corporate confidence, and the most recent Manpower figure is the second lowest in over 30 years. While this in itself is bad news, it could suggest we are getting closer to the trough. |
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| Factor 6: Valuation |
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Valuation can be one of the strongest indicators of where the equity market currently sits, and over the last few months, the valuation case for equities has been getting stronger |
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Despite the sharpest cuts in dividends since 1938, the global equity dividend yield offers good value compared to cash and government bonds. |
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| Table 1: Turning Point Score Card |
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August 2008 |
March 2009 |
| Corporate Earnings Downgrades |
No |
Getting Closer |
| Interest Rates |
Yes |
Yes |
| Inflation |
No |
No |
| GDP Forecast |
No |
No |
| Business Sentiment |
No |
Yes |
| Valuation |
Yes |
Yes |
| Out of 6 |
2 |
3 or 4 |
Source: Citi Investment Research and Analysis. As of 26 March 2009 |
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Please note past performance is not a reliable indicator of future performance.
Source: Citi Investment Research and Citigroup Economic and Market Analysis |
