2018 started the way 2017 ended – markets rocketed up. However, by the end of January bond yields rose significantly and as a result stocks quickly reversed course. The VIX rose from around 9 to 35 in a matter of days. To make matters worse, Trump’s talk of trade tariffs sent markets into correction territory. February was the S&P 500’s first negative month since October 2016 while the quarter saw the index post its first loss since Q3 2015.
April until September saw US markets rise as the Fed signalled its strong outlook for the US economy – contradicting the old adage to “sell in May and come back on St. Leger’s Day”. Outside the US, the trade wars and fears over a Chinese slowdown saw bourses fall. The summer time saw emerging markets panic over tightening monetary conditions with Turkish lira falling 28% in a matter of days. This resulted in the country’s central bank raising its interest rate to 24% while its counterpart in Argentina raised its lending rate to 64%.
Q4 saw markets collapse over fears of a slowing economy and tightening monetary policy. October saw the S&P 500 lose -6.7% while the MSCI ex-Japan went down -10.9%. November saw a slight rebound, but December saw a fall reminiscent of the Global Financial Crisis – the S&P 500 fell -9% and the TOPIX lost -10.4% although other markets fared better (Emerging markets only lost -2.7%). The US bourse had its worst December since the Great Depression in 1932 as the Fed tightened while the US government had a partial shutdown. It had its worst quarter since 2008, down -13.5%, while the TOPIX lost -17.8% over the same period. For the year, all major bourses were negative with the best performing being the S&P 500 (-4.4%) while the TOPIX lost -17.8% and MSCI EM dropped -14.4%.
2019 will see a confluence of factors determine the direction of markets. In the US, an end to the government shutdown or its trade war with China should have a positive effect on markets. Jerome Powell has signalled that the US central bank will pause its rate hikes and could reduce the amount of bonds that runoff the central bank’s balance sheets showing that “Fed put” is alive and well under his reign. As a result bond yields have fallen precipitously over the last few months from around 3.25% to 2.6% providing assistance to global stocks markets. On the negative side, the fiscal stimulus of 2018, which helped generate strong economic growth, is due to decrease which should lower economic growth. The labour market is tightening and wages are rising which could force the Fed’s hand. In China, the war with the US has caused the economy to slow down. This is causing problems for the whole of emerging markets and many of these countries depend on trade with the world’s second largest economy. It is highly likely that China will launch a stimulus program. In Europe, the ECB ended bond purchases last month and is expecting to raise interest rates sometime from September. This may cause the stock market to fall although banks will be greatly assisted.
The sharp drop in stock markets last quarter has made markets substantially cheaper.
Following a turbulent 2018, Japanese markets look outstanding value. The TOPIX trades on P/B of 1.1 and dividend yield of 2.5%. Fixed investment intentions are at a record high while firms listed on the stock exchange generated record profitability. Should there be a halt in the trade war, this country’s markets should be one of the main beneficiaries. Mediocre economic growth does not have as large of an effect on the country’s stock market as people believe because manufacturing makes up a large part of the index and many of those firms have overseas operations.
Asia outside of Japan is the fastest growing region in the world and its stock market valuations are quite modest with the MSCI index trading on a dividend yield of 2.9% and P/B of 1.4.
The US stocks look significantly better valued following last quarter’s debacle and trades on a P/E of 17, dividend yield of 2.2%, and P/B of 2.9. An end to the trade war or government shutdown should boost confidence. Investors should look at whether the Fed slows down its monetary tightening – markets are predicting no more rate hikes this year while the Fed believes it will hike twice. On the negative side, there should be a slowdown in economic growth which could hurt earnings.
European markets look enticing with the MSCI Europe paying a dividend yield of 4.1% and trading on a P/B of 1.6. Investors need to listen to when the ECB plans to raise interest rates. At the end of Q1, the UK is scheduled to leave the EU. There will be turbulence in the run-up to the date, but it remains to be seen what the end agreement will be or if there is a second referendum on leaving the bloc.
Emerging Markets were one of the worst performing regions for stocks with the MSCI index down -14.6%. The region looks promising as it trades on a P/B of 1.4 and has a dividend yield of 3%. Brazil is a country to research as the incoming administration has promised to implement market-friendly reforms. Also, several countries that suffered, including Turkey, could see bounce backs as they were heavily sold last year.
Within stock markets we believe that there could be market rotation from growth to value stocks as monetary tightening causes future cash flows to be discounted at a more aggressive rate.