Investment Outlook - Q4 2018
Ten years on from the Global Financial Crisis, the global bull market continues and is now one of the longest bull markets in history with one constant being investors’ constant penchant to be ‘worried’ about something! For ten years the financial headlines have tended to be on the gloomy side and 2018 is proving no exception, yet the market continues to climb apart from some recent days in October! 2018 is proving to be a year which is resulting in material performance divergence between the ‘haves and have-nots’. We can see a large divergence between the strength of the US equity market and the weakness in Europe and Emerging Markets in particular. The relatively poor performance of Europe and EM reflects some slowdown in growth, as well as concerns over US trade policy and European politics, while the US market has sailed on merrily.
At KBIGI, our central scenario is constructive, and we forecast a more balanced and positive outlook for the global economy into 2019. The US economy will continue to grow strongly above trend, and European economy will grow at or above trend – though at a somewhat slower pace than earlier this year. We expect that Emerging Markets in general will be solid – while there may be ‘accidents’ in particular, smaller, emerging market economies, as is fairly typical. In the US, the Federal Reserve will continue to raise its key interest rate, with inflation in the world economy generally trending higher but not at an alarming rate.
Of course, the greatest risk to this scenario would be a material escalation of the trade war between the US and China.
For equity investors what is reassuring is to point out that fundamentals of earnings growth, dividend growth, corporate activity etc have been strong during 2018 and certainly not as unbalanced as divergent market returns suggest. From our analysis, it is predominantly investor sentiment that has driven this divergence. At this juncture the US is ‘priced for perfection’ while others such as Europe or Emerging Markets increasingly are priced for a quite pessimistic scenario.
Our base scenario is not bearish on the US equity market, as we expect further gains in equities over coming quarters. But we do expect to see better returns outside the US. Relative valuations, positive earnings growth and undervalued currencies are key fundamental supports to this with improved sentiment the most likely catalyst for developed markets, while for emerging markets a clear resolution of trade wars will be required.
Looking to the short-term, there are a number of key events or issues in the coming weeks that bear close watching:
- a final decision on the nature of the UK’s exit from the EU
- results of the US mid-term elections in November
- progress – or not – in trade talks between China and the US
- corporate profit growth during the forthcoming earnings season
- the outcome from Italian budgetary negotiations
We will continue to monitor these and other issues but for now we remain reasonably constructive on equity markets though we continue to favour non-US markets. We are encouraged by the fact that so many market participants worry about when this economic cycle will end – this itself shows that markets are not ignoring important risks.
Asset class outlook: Equities
Our central scenario is as outlined. As per our Q3 update, a material deterioration in US-Sino relations on trade remains the largest equity market risk event we believe.
Apart from relative attractiveness of many non-US developed and Emerging Market markets the same can be said across industry sectors and investment styles. For some time, we have cautioned on the valuation levels of growth and momentum driven styles and highlight the attractiveness of many more value-oriented sectors. Growth has been driven to extreme levels of outperformance by the cheerleading and momentum investing for FAANG stocks in the US and similar names in other markets such as Emerging Markets. Many value-oriented stocks and sectors are much more attractive investments we believe. For these names, stock prices have not reflected the strong underlying fundamentals of earnings, cash flow and dividend growth. For non-growth/momentum stocks poor sentiment rather than underlying strong fundamentals has been the winner, we expect this to reverse.
We are ever conscious that we are at the mature stages of a long bull market and as such when building equity portfolios downside protection is more important than ever. To that end we continue to emphasize quality stocks in our portfolios and focus consistently on items such as not owning:
-Companies carrying excessive debt on their balance sheets
-Excesses of valuation e.g. certain technology stocks
-Companies funded by more expensive corporate credit
Asset class outlook: Bonds
Government bonds should continue to be avoided as we believe they are fundamentally overvalued and remain vulnerable. An unexpected recession would certainly support government bonds
To conclude, the fundamentals remain supportive for further gains in global equity markets but absolute returns from here should be more modest as we are at the mature stage of a bull market. Within markets there is an extreme positioning between ‘haves and have-nots’ and this is something we expect to reverse. The potential for a trade war is the biggest risk.
KBI Global Investors Ltd. is regulated by the Central Bank of Ireland and subject to limited regulation by the Financial Conduct Authority in the UK. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. KBI Global Investors (North America) Ltd is a registered investment adviser with the SEC and regulated by the Central Bank of Ireland The views expressed in this document are expressions of opinion only and should not be construed as investment advice.