It has been a tough couple of months for equity markets, with the ASX 200 down 7.2% and the S&P 500 down 6.5% since the start of October and many investors fearing the worst. However, I believe that recent sharemarket activity is merely a correction in what is still a long-term upward trend, or a 'bull market'. This is likely the result of market sentiment dominated by fear and heightened risk aversion, rather than the underlying fundamentals, which I believe give investors plenty of room for optimism.
Strong US and Australian economic performance
The performance of equities is highly correlated with that of the broader economy; simplistically, when the economy is booming and economic output is increasing, companies tend to generate stronger profits, which is a key driver of long-term share price performance. Therefore, investors should be pleased about the encouraging economic data coming out of the US and Australia, with all key indicators being positive.
The US economy is very strong on the back of the Trump Administration's fiscal stimulus, including the reduction of the corporate tax rate from 35% to 21% and the Administration's extensive deregulation efforts.
US consumer confidence is at an 18 year high, while GDP growth is very strong at 3.5%, the unemployment rate is at a 49 year low of 3.7% and wages are edging higher.
The Australian economy is also showing positive signs, including a strong GDP growth rate of 3.4% and unemployment currently sitting at a 7 year low of 5%.
Robust earnings growth
The widely held consensus among financial theorists is that a company's share price primarily reflects investors' expectations of its future earnings per share, which are often partially or fully paid out to shareholders as dividends. Simply put, higher earnings expectations should translate to higher equity valuations. Therefore, investors should be very pleased with the strong earnings being reported out of the US and Australia.
Companies listed in the S&P 500 have reported exceptional earnings for the 3 rd quarter to date, including year on year earnings growth of 25.7%, which is the highest rate of growth experienced since Q3 2010 according to FactSet.
In addition, FactSet reports that 78% of S&P 500 listed companies reported earnings per share above estimates, while on average companies are reporting earnings that are 6.8% above analyst expectations.
In a similar fashion, almost 93% of companies listed on the ASX 200 reported a profit in FY18, which is only slightly below the record high of 94% that was experienced in the prior earnings season in February, according to CommSec.
Furthermore, the aggregate earnings of ASX 200 companies have risen by 8.4%, or by 20% when excluding key market movers; BHP Billiton Limited (ASX: BHP), Commonwealth Bank of Australia (ASX: CBA) and Telstra Corporation Ltd (ASX: TLS).
Are US/China trade tensions overplayed?
This issue has been worrying investors for most of the year, with many believing it could have significant impacts on the global economy, including Australia, given China is our largest trading partner.
However, Shane Oliver of AMP Capital argues that "it's still not as bad as it looks", highlighting that only 12% of US imports have received a tariff hike, which has averaged around 15%, resulting in an average tariff hike of just 1.8% across all imports.
Investors should also be encouraged that the US has successfully renegotiated trade agreements with key trading partners, most notably Canada and Mexico, with the 'North American Free Trade Agreement' (NAFTA) set to be replaced by the United States –Mexico- Canada Agreement (USMCA). This signals that the US is open to negotiation and isn't interested in long-lasting trade conflicts.
US President Donald Trump has also spoken optimistically about how trade 'discussions are moving along nicely', with China already having lowered tariffs and improving intellectual property protections. It is likely that Trump will want to negotiate a deal before his 2020 presidential campaign.
With the economy typically being a major election issue, Trump will want to avoid hurting the economy through prolonged trade tensions, particularly given how the strong US economy and sharemarket is being touted as one of the major achievements of his presidency thus far.
Foolish Takeaway
With their strong underlying economies and robust earnings growth, I am bullish on the outlook of the US and Australian sharemarket. Therefore, it could be a good time to buy equities, while fundamentals remain strong and the sharemarket sits at a significant discount (relative to earlier this year).
To gain broad exposure to the ASX 200, you could invest into the SPDR 200/ETF (ASX: STW), while you can gain exposure to the S&P 500 through the iShares Core S&P 500 ETF (ISCS&P500/ETF (ASX: IVV)).
