EQUITIES COMMENT: U-turn for Stocks—More Bumps Ahead?
In our last Equities Comment, we highlighted how world stocks excluding the U.S. had slightly negative returns for the year while the U.S. was up over 8%. This changed dramatically in the fourth quarter when U.S. stocks were down 9%, International stocks fell 8% and the TSX declined 10%. (Note: foreign stock returns in Canadian dollars.)
These unexpectedly poor results were driven by a number of factors that were well known.
U.S. China trade war
Brexit negotiations
Decelerating economic growth outside the U.S
Political turmoil in Italy
Some progress was made in these areas during the quarter except for a further of slowing economic growth.
There were also some surprising developments in the quarter that damaged markets.
U.S. bond yields briefly reached seven year high’s in October—higher yields reduce the attractiveness of stocks.
Economic data on U.S. housing and manufacturing softened.
Oil fell dramatically. Sanctions on Iran were implemented in November however, Iran was allowed to sell oil to their 8 largest customers for six more months.This contributed to a surplus in the oil market.
The big question going forward is was this a correction and will stocks resume an upward climb? Or, is this the start of a bear market? Our research indicates this is a correction and we expect stocks to provide positive returns in 2019.
Reasons for a positive stock market outlook:
There is a solid level of economic activity in the major regions (U.S. 3.5%, Eurozone 1.7% and China 6.5%).
Monetary policy makers are either adding stimulus (China recently cut rates) or preparing to hold off on rate increases until growth picks up (U.S. and Europe).
While this is one of the longest economic expansions on record, it’s also one of the slowest.There are few indications of capacity constraints or higher inflation.
Valuations for all major world stock markets have improved with the sell off.
Concerns include:
The trade stance of the Trump government, especially with China.As negotiations drag on, business confidence is being eroded and this negatively affects capital investment.
A lot of uncertainty surrounds the Brexit negotiations and the outcome if no agreement is reached before the deadline.
Negative signals from the bond market are also worrisome.The yields on corporate bonds have increased—a development that often occurs before and during recessions.As well, the difference between short term rates and long term bond yields is very small compared to the normal spread.Historically, this has preceded some recessions.
We have assumed modest earnings growth for the TSX this year and incorporated lower bond yield assumptions. We still arrive at a 17000 target for the TSX. While we expect the road ahead for equities to remain bumpy as markets react to news about trade, Brexit and economic data, there is potential for above average returns in 2019.
