So long and good riddance to 2018, welcome 2019
Last year wasn’t good for equity investors, but attractive opportunities are at hand
FOR ANYONE paying attention to global markets over the past few weeks (as opposed to relaxing on the beach), the volatility was something to behold.
Led by the US, global equities slumped in December and investors sought the safety of bonds as concerns over a slowing global economy, tightening monetary policy and lingering US-China trade tensions turned into outright anxiety. Not content with a stand-off with China, US President Donald Trump has also picked a fight with Congress over funding for his proposed wall on the Mexican border, leading to an ongoing shutdown of the US Federal Government.
HO HO HO, OH NO
Rather than the traditional and indeed hoped-for Christmas rally, US equities slumped in December and dragged other major markets down. It turned out to be the worst December for the S&P500 since the 1930s, with a 9 percent decline. This pulled the 2018 calendar year return down to -4.4 percent, the first negative year since 2008.
While other markets fell with the US, the declines were mostly less severe, somewhat closing the performance gap that opened up between the US and the rest of the world in recent years.
REBOUND
However, during the past few days of December and into January, markets perked up again, buoyed by three macro developments.
First, formal trade talks between the US and China have started following the meeting between President Xi and President Trump at the G20 Summit in Buenos Aires, Argentina. By most accounts, including a Trump tweet, they are progressing well, though there is still a way to go. The slump in US equities in December could put pressure on the Americans to strike a deal, whereas earlier in 2018 it seemed like they had all the bargaining chips with a strong economy and buoyant stock market while share prices in Shanghai were plunging.
The Chinese should also be keen to make a deal, because its economy continues to slow. Retail sales growth fell to the lowest level in almost two decades in November. Import, export and industrial production growth also slowed. Beijing is likely to resort to further monetary and fiscal stimulus to prevent the economy from slowing too much, but the challenge of doing so without adding to the country’s massive private debt stock is substantial.
PIVOTAL
The second, more important, macro development has been termed the “Fed pivot”. While the US Federal Reserve hiked rates at its December meeting, taking the upper-end of its policy interest rate range to 2.5 percent, it also signalled fewer rate hikes in the future.
The “dot plot”, a summary of what officials expect in terms of rates, growth, and inflation, points to two further hikes this year, whereas in September three hikes were pencilled in. The market now expects a pause in rate hikes for a few months.
GROWTH OUTLOOK
US economic data continues to be resilient, even if it is clear that the current pace of growth won’t be maintained indefinitely, nor will all sectors advance at the same pace. The US economy added almost twice as many jobs as expected in December, with payrolls expanding by 312 000 in the month. Meanwhile, annual wage growth rose to 3.2 percent, the fastest pace of pay increases since 2009.
The outlook for economic growth in the US and the rest of the globe is key to whether the 2018 correction was the third intra-cycle reset in the post-2009 bull market – with the other two occurring in mid-2011 and late2015 – or whether it is the beginning of the end.
The underlying economic fundamentals and therefore earnings outlook appears resilient. None of the major recession indicators are flashing red in the US. But global growth has slowed from heady late-2017 levels, and is certainly more uneven and less “synchronised”.
A GOOD END TO A BAD YEAR
Unlike global equities, the local market was positive in December. The FTSE/JSE All Share Index (Alsi) surged 4.25 percent in December, but of course this was not enough to end the year in positive territory. The 8.5 percent loss in 2018 was the first negative calendar year for the Alsi since 2008. While 2017 was a good year for the local market with a 20 percent gain, 2015 (5 percent) and 2016 (2.6 percent) also delivered returns below inflation. This means that over the past five years, local equity returns are barely positive in real (after-inflation) terms.
The JSE was battered by the volatility on global markets, but also by the impact of emerging markets outflows, a weak domestic economy, political uncertainty and importantly, a number of company-specific problems.
The local economy should continue to gradually improve from a surprisingly weak first half of 2018, supported by further gradual policy reforms and higher consumer spending, while the political uncertainty should fade after a noisy run-up to the general election. But ultimately our share prices are set in a global context. As long as global growth remains reasonable, and there are no further episodes of emerging market risk reversal (that is, massive capital outflows and an exchange rate slump), 2019 should be a better year for the local market.
A silver lining of the market turmoil is that the oil price, already under pressure from record US production and sliding demand, slumped a further 10 percent in December to $53 (R726.30) a barrel. It has rebounded somewhat since then, but at current levels still translates into relief for motorists, in milder inflation, less upward pressure on interest rates and a narrower current account deficit.
Petrol price cuts totalling R3 per litre in December and January, and the rand back below R14 to the dollar means the local inflation outlook is subdued. This should give the Reserve Bank reason to pause on its hiking cycle too. After all, a weak economy is putting downward pressure on those prices that are subject to market competition and influenced by demand.
Prices set by the various levels of government (including electricity tariffs and municipal rates) and globally (fuel prices) are not influenced by domestic demand and hiking interest rates to constrain them seems counter productive.
HANG IN THERE
Last year was a massive disappointment for investors. Almost everything that could go wrong for the local stock market did. Global returns were only positive for local investors thanks to a weaker rand. Only local bonds and cash outperformed inflation.
The flip-side of negative returns from equities in 2018 is that valuations have become more attractive. Prices fell, but the earnings ability of global companies remains intact (even if somewhat less than previously thought) while it should improve for local companies.
Now is a good time to remember legendary American investor Howard Mark’s two rules for investing. Rule one is that most things on markets are cyclical, while rule two is that some of the greatest opportunities for making or losing money come when other people forget the first rule. The cycle will turn; we just need to be patient.