The final quarter of the year has seen warning signs in markets, and things could become more serious since few asset classes are delivering positive returns year to date.
The US stock market has begun to falter and, in stark contrast to much of 2018 and 2017, volatility has also picked up significantly.
While investors have been rewarded for simply being exposed to markets in recent years, 2018 has not been so straightforward.
We suspect 2019 will require an even more discerning eye and the ability to draw from a wide variety of tools to both protect capital and deliver returns, especially if tightening financial conditions and slowing growth present themselves in a meaningful way.
This year the US economy performed strongly, as GDP growth continued to accelerate until the second quarter of this year, having done so for a total of eight consecutive quarters.
Performance of selected US stocks vs MSCI World ex US index in the past 12 months
While the acceleration stopped in the third quarter, relative economic outperformance continues, despite indications of a slowdown from the OECD’s leading indicator. The Federal Reserve has been raising interest rates slowly, inflation is under control, and the US dollar has remained resilient.
However, while a more granular analysis reveals these conditions helped to drive US performance, they dragged on performance in the rest of the world, particularly for emerging markets with high levels of US dollar debt and large current account deficits.
But this only tells part of the story. Simply looking at the top-line S&P 500 performance, which reached all-time highs in September, it would have been tempting to assume that all was well.
The primary contributor to this was the technology sector’s strong performance and outsize market share, despite interest rate sensitive sectors such as homebuilders and car makers struggling, well before the ‘Faang’ stocks (Facebook, Apple, Amazon, Netflix and Google) were hit in October. Even the US was not as robust as it looked at first glance.
• The US stock market has begun to falter.
• Next year is not expected to show the same growth as 2018.
• Political uncertainty is likely to continue into 2019.
Turning to 2019, recent global growth downgrades by both the International Monetary Fund and the OECD are an obvious headwind, and this may require policymakers to once again intervene to get global growth back on track.
But this is a tall order. On the fiscal policy side, the US tax cuts helped to drive outperformance, but the benefits are fading and the stimulus must be funded.
In terms of monetary policy, the European Central Bank and the Fed are still unwinding the easy money that has supported markets for nearly a decade. While the ECB is most likely hoping it has not left it too late, the Fed’s rhetoric has softened, emphasising a return to “data dependency”.
Since this may have temporarily assuaged investors’ fears over the Fed tightening too fast, there are still some slightly worrying signs coming out of credit markets, with the US high-yield market starting to show signs of stress, and a worrying amount of investment-grade issuers in both the US and Europe on the cusp of ‘junk’ status. Further deterioration here would be worrying, even if the Fed pauses.