The danger in 2019: markets’ dim view of the economy may become a self-fulfilling prophecy
- Hannah Anderson says 2018 was a tough year for investors grappling with market sentiments that were persistently more pessimistic than actual conditions.
- Policy decisions and political tensions will continue to matter in 2019
At the end of a calendar year, it’s natural to take stock of the past year and adjust one’s expectations for the future. At the close of 2018, that process was rather unpleasant for most of us and raised more questions than it answered.
Why was 2018 so tough for risk assets? Does the market know something we don’t about the economy in 2019? And, if the economic outlook is relatively stable, but markets are still moving in a risk-averse direction, is there a point at which deteriorating expectations for fundamentals causes an actual deterioration in fundamentals? Put another way, does perception always eventually become reality?
Between September 28 and December 24, effectively the fourth quarter of the year, the S&P 500 equity index fell by 19.3 per cent, skirting bear market territory on more than one occasion. For the whole year, US equities were only down 4.4 per cent – not much consolation for those experiencing the full breadth of the moves.
US fixed income did not provide much of a cushion to the fall in US equities. Measured by the Bloomberg Barclays US Aggregate index, fixed income gave investors zero per cent in 2018. Corporate credit and emerging market debt were buffeted by the same risk-averse sentiment plaguing equity markets.
Overall, cash was the best performing asset in 2018. US dollar cash returned 1.8 per cent in 2018, the first time in at least 20 years that cash was the best-performing asset class.
There are several potential explanations for the year-end market downturn, which can be surmised as: investors believe 2019 will be a significantly more challenging year for growth, earnings and policy. Investors are probably correct, but slower growth or rising rates are phases that can last a long time, and based on current information, the market may be a bit too pessimistic about the year ahead.
Economic growth is moderating in most economies, notably slowing in the second half of 2018 in Europe and China. Industry surveys point to a continued slowdown in both. China looks likely to step up policy actions to mitigate that slowdown, but Europe has little room to intervene. In the US, business confidence surveys have begun to trend downward, but consumer sentiment remains relatively stable; collectively, this points to lower investment and stable consumer spending, and thus more modest growth in 2019.
Notably for equity investors, earnings revision ratios – the change in expectations for 2019 corporate earnings in earlier months versus current expectations – have turned negative for most major markets. However, most of the markets now look attractive from a valuation standpoint after the late-2018 sell-off. Present valuations may draw some investors back to equities in the short term.
Taking stock of 2018 policies and readjusting expectations for 2019, policy seems to be the biggest factor in recent investor unease. Last year was a challenging one from a political perspective. This year is likely to produce just as many political headlines – US-China trade tensions and Brexit spring to mind.
The bigger policy headlines in 2019 will be from central banks, particularly the US Federal Reserve. Indeed, the Fed’s decision to raise rates at its mid-December meeting and its communication that it would continue doing so next year seemed to spark the recent flight from risk assets. Investors are naturally worried about a policy error.
Liquidity conditions are likely to tighten further; central banks will stop being net providers of liquidity through asset purchases as they wind down their balance sheets.
This will be another volatile year for markets. Investors don’t seem eager to ring in the new year and sentiment remains relatively weak. Whether this pessimism creates a self-sustaining loop of weaker data and weaker asset performance is an open question but, at this point, markets look to be a bit too gloomy about the year ahead.
Hannah Anderson is a global market strategist at JP Morgan Asset Management