In hindsight, 2018 may not have marked the end of the bull market but rather a classic pause—and while this year could be bumpy, when the dust settles, the bull may still be running.
Two decades ago, Europe was coming to terms with a common currency, U.S. unemployment hit a new low point, and stock investors were debating whether high valuations were the product of “irrational exuberance” or a “new economy” paradigm.
Whereas investor sentiment in 1999 could be summed up as fear of missing out, today's investors are driven by a fear of losing.
In hindsight, 1999 turned out to be a prosperous year, with the Standard & Poor's 500 up more than 20% and the MSCI World Index returning more than 25%.
History seems to be repeating itself, as investors try to make sense of mixed signals at every turn. Yet, today's environment has one critical departure from the end of the last century/millennium: Whereas investor sentiment in 1999 could be summed up as fear of missing out, today's investors are driven by a fear of losing.
This is true in U.S. markets, with its abundance of cash on the sidelines and the 2019 consensus price-to-earnings multiple of 16.5 at about half its level in 1999. It's true for China, where stocks recently touched their lowest valuations since 2014. And it’s true for Europe, where value stocks are trading near 20-year lows.
It’s worth pointing out there are also many differences between 1999 and now, but it still can be said that that investors who are waiting on the sidelines for a major pullback could be waiting for a while. Markets will likely experience more volatility, and periodic pauses, but when the dust settles, 2019 could shape up to be a good year for equities in major global markets.
As my colleagues and I have said many times before, bull markets don't follow straight lines. They rally, retest, pause and recover. After accounting for year-end losses due in part to tax-loss harvesting and liquidity constraints, 2018 was indeed a pause year. The double-digit returns so far in 2019, meanwhile, fit the mold of post-pause recovery.
We've seen this before, including in 2011 and 2015—when investors turned pessimistic and cashed out—only to see the market come back in the following years.
Since 1984 There Have Been Seven S&P 500 Correction in Expansions.
All Were Ended by Central Bank Moves.
|Year||S&P 500 Correction||S&P Two Months After Low||S&P Eight Months After Low|
Although the strength so far this year suggests that the post-pause bounce has run its course, we think there is still room for improvement, though with choppiness along the way. With the corporate stock buybacks in a blackout period, the Mueller Report forthcoming and a China trade dispute still unresolved, investors shouldn't be surprised if the market takes a time out in the near term.
Looking ahead, there are several reasons to be positive, including: market-friendly Federal Reserve policy, reasonable valuations—the S&P 500 was recently less than 15 times 2020 forecasted earnings—and various signals suggesting that an economic recession is not imminent.
There is also a great deal of cash sitting on the sidelines. Notably, December saw the greatest net liquidations from equity mutual funds and exchange traded funds (ETFs) of any month on record, and although some of that money appears to have come back into the market, there still remains money on the sidelines.
And while there is a lot of discussion about an earnings recession, that risk may be subsiding. Estimate cuts are decelerating, with revisions no longer moving down with the same magnitude seen in the fourth quarter. Don't be surprised if 2019 full-year earnings per share growth estimates reverse course from their year-to-date slide.
The adage that markets stop worrying when politicians start worrying is apropos for China today. The central government has recently taken action to stimulate growth—though in a way that emphasizes public investing, as opposed to debt-fueled overinvestment.
Meanwhile, earnings revisions are turning positive—and domestic investors are starting to come back into the market. Moreover, MSCI just announced that it will increase index weightings of China A-shares —stocks of Chinese companies incorporated on the mainland, quoted in renminbi, and listed in Shanghai and Shenzhen in its flagship MSCI Emerging Market Index. The weighting will climb from 5% to 20% between now and November.
Although China's markets may be due for a pause in the short term— the market was recently up more than 23% year to date—its 12x multiple is still well below average, having recovered from 9x at the beginning of the year. The last time China A-shares fell to such levels—in 2014—the market continued to rise over the next year and a half.
Finally, Europe continues to be a source of controversy. While it has been a big disappointment from a market-return standpoint so far this year, a disconnect still persists between what is happening, both economically and politically, and how markets are responding.
Global investors are extremely underweight Europe; hedge fund exposure to the region is in the fifth percentile1. Those who are still invested are particularly defensive, with prices for the highest-quality stocks beyond expensive.
Meanwhile, value stocks have recently traded near a 20-year low. While European equity could stay in the doldrums, investors who weigh the odds in Europe might find more upside potential than downside risk, at least in the short term.
1 Morgan Stanley International Prime Brokerage, Morgan Stanley Research, MSCI Barra.
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