While in 2018 the emerging markets were the precursors of the downturn, they were closely followed by the European indices, and then by a major correction on the US market (-24% between 3 October and 24 December). At the start of a new stock market year, the key issue is to work out if the bottom is close.
The rebounds on 26 December (NASDAQ +6.16% and S&P +4.6%) and 4 January are indicative of both the excessive nature of the correction and the risk of adopting an excessively defensive stance.
Despite the impact of algorithms and equity market “momentum traders” amplifying movements beyond what the fundamentals would suggest, what pointers can help us evaluate the situation?
Global economic growth is forecast at around 3.5% and is slowing (unlike the start of 2018, when it was accelerating). While global growth has barely moved, in Europe it has declined
significantly. The plunge in the manufacturing ISM in the first week of January (its biggest drop since October 2008) confirmed the slowdown in the US economy for 2019 and revived
expectations of a global downturn at the end of a long cycle of growth projected for 2020.
This slowdown should reduce US growth to around 2%, which is not a recession.
Deteriorating prospects for growth and the markets brought down long rates (fall in the 10Y and 30Y). However, the relationship between interest rates and equities has become
stretched during this long period with rates at close to zero. This decorrelation was accentuated in January 2018, when the US Treasury-financed corporate tax cut led to a
fiscal premium being priced into long-dated government bonds. This did not prevent a fresh wave of market falls when the Fed hiked interest rates at its December meeting. The Fed has
embarked on a phase of "quantitative tightening". It should remain pragmatic, but in this environment, we cannot expect to see growth in equity market multiples.
Corporate earnings have been revised down. While the consensus earnings forecasts that we use show growth of around 10% for 2019 in both the US and Europe, we project 2019
earnings growth at 4-5%, based on the assumption of a slowdown.
Lastly, flows remain stubbornly negative at the start of 2019, with the surge of outflows from equities continuing and no signs of a move into risky assets. The increase in the proportion
of cash being held is a clear indication of risk aversion.
In these extremely volatile markets, many movements appear irrational, or at the very least, excessive. 2018 clearly showed us that geopolitical developments affect the economic outlook on which we base our decisions. Slowing, but positive, economic growth, along with the third consecutive year of corporate earnings growth, should support positive a market performance in 2019 following the excessive correction of 2018. Nonetheless, the combination of these positive fundamentals and the major unresolved political issues will keep volatility high, with no particular trend emerging on the markets. We are taking a cautious approach to exposure and risk management, while maintaining a selection of securities based on growth and quality, which should enable us to take advantage of the opportunities presented by the fourth-quarter falls. It is hard to see a trend reversal in the short term, although the general pessimism will undoubtedly provide some repositioning opportunities.
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