Strong quarter for global markets likely a ‘reckoning deferred’
Recovery in growth sectors that struggled in 2022’s down markets led a strong first quarter for global equities, with the MSCI World Index finishing the period up 8 per cent despite banking sector turmoil and the persistent inflation threat. But the improvement may merely be an economic reckoning deferred, analysts warn.
The strong performance in Q1 follows a 10 per cent increase in the final quarter of 2022 for the MSCI Index, which has stayed in positive territory throughout 2023, according to Morgan Stanley. “The market was led by the growthier sectors that suffered last year: information technology, consumer discretionary and communication services,” says Bruno Paulson (pictured), managing director of Morgan Stanley Investment Management’s international equity team.
“Even banks held up reasonably well despite the assorted failures, off only 4 per cent in the quarter,” he adds. “The performance in the quarter was driven by a rerating, as the forward earnings multiple rose by over one point while earnings were flat.”
According to Ron Sargeant, portfolio specialist at Touchstone Asset Management, 2022 was defined by the “long-overdue normalisation of interest rates” after an extended period post-GFC in which investors focussed mainly on revenue growth and less on cash flow and balance sheet analysis.
“In 2023, markets were abruptly reminded that the value of a company is a function of its present capital structure and its future cash flows,” he says.
While global markets were up in Q1, Touchstone found only 13 per cent of ASX200 results beat forecasts, while 28 per cent missed; misses were skewed to smaller companies. “This ratio of 45 per cent beats to misses is the lowest we have observed in five years, well below the average of 76 per cent,” Sargeant says.
He also noted that the price reaction was greater for misses than for beats and that misses were “punished more than historical experience”, calling this a symptom of deteriorating economic conditions. Moreover, the sector that performed the best in Q1 was consumer cyclicals, which benefitted from unsustainably strong consumer spending and will likely perform worse from here.
According to Paulson, the recent rises have left the market looking “far from cheap, with the forward multiple of 16.2x at a level 15 per cent above the 2003-19 average, though perceptions may be skewed by the bubbly near-20x multiples of 2020-21.
“Bearing this in mind, it is very difficult to argue that the market is pricing in any significant economic slowdown, given a healthy multiple on these elevated earnings,” he adds. “This is worrying if you believe that the current economic robustness could only be temporary, and that the economic reckoning may well have merely been deferred rather than avoided.”
Citing the ongoing macroeconomic uncertainty, Sargeant says the time is optimal for owning quality companies with some resilience to negative external forces.
“As the year progresses and the downturn matures, we expect to have the opportunity to add further high-quality companies that have used the turmoil of the past few years to consolidate market share, hire good people from weakened competitors, reduce costs or opportunistically acquire cheap assets.