It's a big week for US investors, with news due on monetary policy, the economy, and earnings. The combination is likely to confirm that the world's largest economy is weakening, with GDP growth falling below trend for the third quarter, manufacturing activity continuing to contract, and employment growth slowing. Earnings releases from 164 S&P 500 companies look set to confirm that profit growth is decelerating. And markets are expecting this broad deterioration to lead to a third rate cut this year from the Federal Reserve, which announces its decision on Wednesday.
As uninspiring as this outlook seems, our base case is that the US slowdown will not turn into a recession in 2020. We expect US stocks to outperform the Eurozone, where growth dynamics are even weaker and valuations look strained.
* US growth is still outpacing the Eurozone. The consensus forecast is for US growth to slow to 1.6% for the third quarter, in what would be the weakest reading so far this year, with the rate of net job creation declining to 90,000 in October from 136,000 in the prior month. The US ISM manufacturing survey, which fell to its lowest level since 2009 last month at 47.8, should continue to point to a contraction of activity, likely remaining below 50. Overall, however, we expect the US economy to grow by 2.3% for 2019, versus just 1.1% for the Eurozone. In 2020 we believe the US will also grow faster at 1.2%, compared with the Eurozone's 0.7%. The consensus forecast for third quarter growth has the region growing at the slowest pace since 2013.
* Profits in the US remain positive, while the Eurozone is contracting. We anticipate US earnings growth will decline to –2% for the third quarter, with growth of just 0.7% for 2019 as a whole. That still looks better than the Eurozone, where large-cap indexes are more exposed to the global industrial slowdown. As a result, we expect profit growth per share of –5% in the Eurozone for the third quarter and –4% for the year overall. Meanwhile, we think Eurozone stocks have not adjusted sufficiently to this weaker outlook, with the current 12-month forward PE of 13.7x trading above the 10-year average of 12.5x and pricing in earnings growth of 10.5% in 2020.
* The Fed has more scope to support growth than the European Central Bank. Federal Reserve officials have not contradicted market perceptions that the funds target rate will be cut to between 1.5% and 1.75% this week, the third interest rate reduction of 2019. That still leaves room for significant further easing from the Fed over the coming year. By contrast, we foresee just 10 basis points more of easing from the ECB over this period, with rates already at –0.5%.
So we prefer US stocks over their Eurozone counterparts, despite the deteriorating economic and earnings outlook for the US.