2018 began with a bang…and ended with a bust. After a string of 15-months of positive performance for global markets that commenced in November of 2016, 2018 was capped by the worst quarter since 2011*. Global stocks, as measured by the MSCI All Country World Index, fell 7% in December and more than 9% in 2018, while the US stock index, the S&P 500, declined 9% in December and over 4% for the year. What changed so drastically from the year prior?
The unprecedented fall in the US equity market last month was influenced by a multitude of fears, but characterized by two main concerns — trepidation of a slowing economy and worry about a “policy error” by the Fed.
Signs of decelerating global economic growth have unnerved investors: Economic data coming from China, Europe, and Japan were below expectations in recent months, while falling oil prices exacerbated concerns of weakening in global demand growth. In the US, 2018’s economic growth that was bolstered by corporate and consumer tax cuts is widely anticipated to wane in 2019. And more recently, investors have become concerned with the impact of retreating globalization—most notably, through rising trade tensions—a trend that we believe won’t ebb in the period ahead. The effect of protectionism is evident by lowered earnings guidance for many US companies, as they integrate the impact of tariffs and slowing sales in overseas markets into their forecasts.
This expectation of slowing growth, however, should not be a surprise to investors. We’ve been anticipating a deceleration of global growth from the pace of recent years. We estimate global GDP growth of 2.9% in 2019, down from 3.1% in 2018. But it’s important to keep things in perspective: What we’re talking about for now is not a sharp slowdown or recession. It’s just a natural deceleration. We attribute the slower growth to idiosyncratic issues in individual countries, rather than to a common global thread. In the US, for instance, the consumer drives the economy, and with already low unemployment and lapping benefits from fiscal policy, the US should grow closer to 2% this year, down from 2.5%.
Given these growth concerns, investors hoped for a more accommodative signal from the Fed at their December 19 meeting. Instead, they were disappointed by the Fed’s forecast signifying that two rate hikes in 2019 would still be appropriate. Many market participants were anticipating only one. Just to be clear, the reduction to the forecast is a close reflection of the recent market volatility, and lower oil prices (i.e., inflation) are not an indication of a material economic slowdown.
In our blog, “Fewer Fed Hikes In Store — But Not Because the Economy’s Faltering,” we reiterate that the economy is on solid ground, and attribute the shift in the Fed’s forecast to a change in their policy-decision making process to be more data dependent. In other words, if economic data weakens, the Fed will slow its tightening actions. This data dependence reduces the risk that the Fed will make a policy mistake that could derail economic growth, in our view.
Slowing economic growth together with the unknowns around trade, rising inflation, and the Fed, we believe, will cause volatility to remain high in 2019, especially during the next few months. Importantly, these concerns will not be eliminated quickly, leaving room for continued uncertainty around growth.
But as noted above, stocks have declined significantly from 2018 highs. And while we concede that there are worries, we believe the markets overshot in December, signposting a direr outlook (a recession even) than we consider likely. Specifically, US stocks appear to be pricing in no earnings growth for S&P 500 companies next year (Display). Using that zero-growth assumption, current valuations are close to their average since 2008 and when interest rates are below 5%. Notably, they’re also less expensive than the average over the last 25 years.
Margin of safety should ease concerns
So, what’s the takeaway? In our opinion, valuations, at their current levels, provide a margin of safety for long-term investors. We don’t think it’s a stretch to expect positive, albeit modest, returns over the foreseeable future. No one knows precisely how the next several months will play out, but we’re comforted by the discount, given the fundamentals, that stocks have already priced in. Although it’s always jarring to experience drawdowns to the degree that happened in December, investors with a long-term horizon should look beyond the short term and maintain their strategic allocation designed to get them to their long-term goals
*Global stocks represented by the MSCI All Country World Index
The views expressed herein do not constitute research, investment advice, or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.