2018 was the S&P 500’s worst year (-6.2% YoY) since 2008, while the MSCI World Equity Index dropped 10.4% YoY. For the first time in years, all major global asset classes produced negative real returns. Emerging markets (EMs) bore the brunt of the risk-off environment, with the JSE All Share Index closing 2018 with a 11.5% negative total return (over four years it has yielded a paltry 4.6% annualised total return). Numerous factors conspired to create negative global sentiment, especially in Q4 2018. Global growth prospects, and the related central banks’ policy responses, are typically the biggest market drivers. While growth should slow this year (we see a circa 3.5% 2019 global growth rate as enough to drive reasonable earnings growth), market behaviour suggests a far worse outcome, probably due to a lack of confidence in US President Donald Trump’s antics. After being a positive market catalyst in 2017, 2018 was the opposite and the US stock market is now at levels below those when dramatic tax cuts were implemented.
Below, we outline what we think will dictate 2019 equity market returns:
- Markets valuations are cheaper than this time last year with US markets’ ratings dropping around 30%. 2019 expectations are still for positive US earnings growth of around 8-9%, implying a 12-month forward P/E of 14.6x – the cheapest in six years and below a 10-year mean. Excluding tech shares, the multiple falls to circa 13x. The All Share Index’s derating has been less pronounced over longer, but it trades at a forward multiple of 11.9x – below the 10-year mean (12.9x).
- US economic growth should slow this year but it is highly unlikely 2019 will see the economy moving into a recession. Evidence points to an economy that is in very good shape – the longer that continues, the more supportive for equity market valuations.
- In this US rate-hiking cycle, the Fed hiked gradually and responsibly in line with growth conditions and we don’t see a reason for this to change. We expect the Fed to hike rates once or twice (by 25bps each time) in 2019 but, based on slowing US growth, it should then pause and wait for further signs from the economy. Historically, this has led to a weakening dollar, which has been positive for risk assets, particularly EMs (which could lead the charge in 2019).
- Trade war escalation in 2018 weighed on risk appetite and for good reason – recent China data has shown a marked growth slowdown largely due to uncertainty around trade. China is crucial to the global growth outlook and we think sanity will prevail, which should be a major boost to global equity markets with EMs likely to benefit the most.
- Signs of positive eurozone growth have been overshadowed by populist rhetoric from certain eurozone countries. Italy joined the fray in mid-2018 but, unlike Greece in 2017, its economy is the fourth-largest in the zone so any stress to its balance sheet could send shockwaves across the region. Brexit is an ongoing saga and 30 months on we are no closer to knowing the outcome.
- SA politics & economic growth: SA is in a stronger position than a year ago, albeit off a low base. 2018 saw negative 1H GDP growth, with a rebound above 2% in 3Q. Political rhetoric should dominate headlines leading up to the election, but our base-case is for the ANC to win with enough of a margin to empower President Cyril Ramaphosa to continue reforms. Inflation is unlikely to force the SARB’s hand and, given the global context, rates may have peaked/come close to peaking. Structural problems remain, but 2019 should be better for local firms.
While 2018 saw high anxiety levels, history is on our side in 2019 – since the 1950s, every year the S&P 500 de-rated by more than 1x, the following year’s average return was 16% and on only two occasions was the return negative the next year. Global markets are circa 30% cheaper YoY and many current headwinds can be addressed by political leaders. It would be in their interest to act in a manner positive for reasonable economic growth and we think markets are acting with extreme risk aversion and deducing an outcome worse than what will materialise. The S&P 500’s annual compound return over the past four years is 4.4% – less than half the long-term average, thus dispelling the myth we are at the end of a rampant bull run, with the market becoming progressively cheaper in recent years.
Prospects of a positive 2019 have improved given the Q4 2018 sell-off. EMs could outperform in this scenario (SA-positive). Current conditions are conducive to volatility, but investors who keep cool heads and stay invested will be rewarded with meaningful returns.