Macroscope | Why Federal Reserve rate hikes and US market fundamentals should cheer bearish investors

After a horrendous year in financial markets, with nearly every major asset class delivering losses, investors deserved a Santa Claus rally. 

While there are still several more trading sessions left this year, the Christmas feel-good factor is conspicuously absent in equity markets. According to data from Bloomberg, the benchmark S&P 500 index is on course for its second-worst December on record and remains firmly in correction territory, typically defined as a drop of 10 per cent or more from a recent high. Other major equity indices, notably in Japan, continue to suffer sharp declines. In the past three months, the MSCI World Index, a leading gauge of stocks in developed economies, has fallen more than 13 per cent.

On a global level, a staggering US$15 trillion has been wiped off the value of equity markets since late January, according to Bloomberg, with China accounting for 13 per cent of the losses. More ominously, the world’s banking stocks slipped into bear market territory – a drop of 20 per cent or more from a recent peak – in the second-half of this year in a sign of the severity of the deterioration in sentiment.

The latest fund manager survey published by Bank of America Merrill Lynch on Tuesday revealed that investors’ allocation to global equities has fallen to a two-year low, triggering the largest-ever one-month rotation into bonds as inflationary pressures subside. The catalyst for the dramatic shift out of stocks is mounting concerns about growth. According to the survey, investors are the most bearish on the outlook for the world economy since the 2008 financial crisis.

The reasons for pessimism are well known: the withdrawal of monetary stimulus led by the Federal Reserve; the simmering US-China trade war; and signs of a regime change in markets as a long period of calm gives way to a surge in volatility. Worries about corporate earnings – particularly in the United States, where profit growth is set to slow sharply next year after reaching 20 per cent this year – and a fierce sell-off in once high-flying technology stocks are adding to the gloom.