18 Jan Q4 2018
A year to forget
The robust earnings growth went largely unrewarded on concerns that the longest bull run in history would soon end. Rising interest rates, overblown recession fears, trade war anxieties, slowing global growth, and replacing quantitative easing with quantitative tightening, all impacted on investor sentiment.
But it was not just equities that were affected. 2018 proved to be a devastating year for almost all asset classes with widespread collapses in most investment categories. Deutsche Bank has maintained a data base of broad asset returns covering 70 investable assets going back over 100 years.
It includes equities, bonds, commodities and cash. In 2018 only 7 of the 70 categories (10%) finished the year with a positive return in dollars. The 90% that recorded negative returns was the worst annual outcome ever – and the records go back to 1901!! There was almost no place to hide. Accompanied by extreme volatility, it was one of the most turbulent in recent memory.
In the tenth year of the recovery, worries about the end of the global economic up-cycle are understandably widespread. However, actual forecasts for world growth in 2019 predict only a mild cyclical slowdown.
Although global PMI’s have been falling steadily throughout 2018 (from over 55 to 51.5) they are still in positive territory. [CHART 3] Fears of the impact of failed trade negotiations have no doubt influenced these forward-looking surveys, but actual forecasts will not have built this in. The OECD forecast for global GDP growth in 2019 is estimated at 3.5% – only marginally below the 3.7% in 2018. [CHART 4]
Equities have clearly been influenced by the PMI trends rather than the relatively benign formal economic forecasts (hardly surprising as equity investors are traditionally forward looking). Equities are now pricing in a severe slump in earnings based largely on possible damage from the trade war
From the depressed levels at which global markets ended the year there is a reasonable likelihood of a positive outcome for world equities in 2019. Prevailing valuations are below long term averages and earnings growth forecasts (although being trimmed) are still quite reasonable at +9% for the year. This is off last year’s high base and we are sceptical that it will be achieved. Nevertheless, we cautiously expect positive, but below-average, returns across markets from these depressed levels. Equities should outperform bonds as another rate hike (or two) will compress capital values and result in low overall returns.
The degree of upside in equities will be heavily influenced by the outcome of the trade negotiations and the extent to which the developing slowdown in China is arrested by stimulus action. The deceleration in global economic growth, and reductions in forecast earnings, will weigh heavily in this late-cycle phase. Despite a more dovish Fed, and the fact the rates are already close to ‘neutral’ (the rate at which it will neither promote nor inhibit growth), the ongoing winding down of the Fed’s balance sheet will keep liquidity relatively constrained.
Of course there are, as always, risks to the outlook. The crucial issue is the outcome of trade negotiations. Should these flounder, a resultant escalation in trade tensions would damage sentiment materially, and raise the risks of a deepening slowdown in China. Latest indications do, however, suggest a positive outcome with the recent dramatic turbulence in both the US and Chinese markets clearly a vital focus point for both sides.