An index that measures how much actual data misses estimates has gone from bad to worse
Morgan Stanley has downgraded global equities to underweight, citing growth challenges
Asian equities fell sharply on Monday, with Indian stocks joining their Chinese and Korean counterparts in leading the retreat. Each of these markets fell by over 2%, while others such as Australia and Japan corrected by about 1% each.
For the Indian markets, weak global news coincided with disappointment with the Union budget, which had negative tax-related announcements and lacked the fiscal stimulus some equity investors were hoping for.
Then there was some confusion whether a hike in taxes for the rich also applies to certain structures used by foreign portfolio investors (FPIs). However, FPIs, themselves, didn’t seem too worried about all of these India-specific concerns, going by the mere ₹400 crore net selling by them on Monday.
From the looks of it, Indian equity investors are waking up to the same concern that has got investors worried globally – weak global economic data.
Foreign brokerage house Morgan Stanley downgraded global equities from equal-weight to underweight citing economic growth challenges. It points out that investors are too optimistic about corporate earnings in spite of the worsening macro-economic data.
A look at Citigroup’s Global Economic Surprise Index shows that concerns related to high optimism are valid. The index, which measures how many times actual economic data bears or misses estimates, has gone from bad to worse.
Readings in the negative territory indicate that economists around the world have been too gung-ho about growth. Citigroup’s Economic Surprise Index for emerging markets (EMs) has shown a similar trend.
Highlighting the conundrum between equities and macro data, Morgan Stanley said that while stock markets have rallied over the last month, global trade and purchase manager’s index data have continued to worsen.
It further added that equity investors are betting on loosening monetary policy to aid economic growth. “We think a repeated lesson for stocks over the last 30 years has been that when easier policy collides with weaker growth, the latter usually matters more for returns. Easing has worked best when accompanied by improving data," it said in a report on 7 July.
According to Neil Shearing, group chief economist, Capital Economics, there are two potential explanations for the strength in equities. “The first is that investors believe that the world’s central banks, led by the Fed, will save the day and that policy easing will stimulate growth that in turn supports equity prices. The second, less optimistic, explanation is that the equity market is simply lagging behind the bond market and it will eventually succumb to the realities of a more challenging growth outlook," he said in a note on 1 July.
Needless to say, with economic and corporate data weakening, stock valuations have risen to unreasonable levels. Although one-year forward price-to-earnings multiples of equities around the world have eased from their recent highs, they remain high relative to underlying earnings growth. No wonder then that Morgan Stanley suggests being underweight on global equities at current levels.