INSIGHTS

Mihai Nechita

Fri, Jan 4


Stock Watch - 04/01/2019

2018 turned out to be a less prosperous year for the typical “buy and hold” strategy in equities, with all the major indices recording a steep sell-off in the last month that brought the annual 2018 performance deep in the negative territory.

Table 1 Quarterly and 2018 Returns for Major Indices

Data Source:  Bloomberg

The year started on a positive note following economic expansion in Europe, the impact of the tax reform on corporate America and improvement in the Chinese economy. The positive sentiment was first tested at the end of January when President Trump announced tariffs on imported solar panels and washing machines, the first measure in the US-China trade war. This was followed in March by the steel and aluminium import tariffs. By September, following different announcements the Trump Administration had imposed tariffs on $ 250 billion worth of Chinese imports. With the majority of the imposed tariffs carrying an initial 10% levy, with a plan to be increased to 25% in January 2019. However, during December’s G20 Summit in Buenos Aires, a 90 days temporary truce was agreed by both parties, whereby the US will hold off the tax hike to 25%, and refrain from imposing the scheduled tariffs on $ 267 billion worth of Chinese goods as previously expected.

The US Federal Reserve has continued its path of interest rate normalisation with Decembers 25 Basis point hike, but the hawkish tone expressed at the beginning of the year slowly transformed into a dovish one. Meaning the market remains less optimistic of a continuation of the hiking cycle as we move into 2019.

In Europe the growth trend that characterised 2017, was not continued into 2018, with Germany recording a quarterly GDP contraction in the third quarter of 2018. Later in the year the Italian budget controversy added to already a volatile market. 

In the UK, Brexit has dominated the headlines and uncertainty surrounding the outcome has pushed the markets towards new lows, even though the economy has still recorded expansion.

As we approached the end of the year, there is a noticeable shift in optimism regarding global growth in general, and coming from the particular strength seen previously, a turn in the fate of US growth towards a more negative outlook perhaps raises the greatest of concerns.

 

US

Data Source:  Bloomberg

The year opened with a continuation of the 2017 positive momentum. A first 10% correction on S&P 500 was recorded in February following the first action in the US-China trade war. The S&P 500 found a footing at the 2580 level. After a first attempt to recover this level was retested at the beginning of April. For the following 6 months S&P 500 had a positive trend and made new highs with the all time high being recorded on 20 of September 2018. This was fuelled by better than expected growth and corporate earnings. At the beginning of October, we have seen the market retesting the previous high but failed to establish a new high.

At the sector level, (please see the table below) as the year has progressed, defensive sectors as healthcare and utilities have outperformed the market in absolute and relative term, being also the only sectors that return positive for the year. In relative terms the information technology sector and consumer discretionary sectors have had outperform the index.

Note: The colour scheme reflects the performance of each sector relative to S&P 500
Data Source:  Bloomberg

 The last quarter was a specially disappointing one for FAANG stocks. With a total weight above 16% in S&P 500 and 44% in Nasdaq 100, the performance of these stocks has been closely monitored. As seen on the table below, for the whole year Amazon and Netflix provided a double-digit return whilst holding Facebook and Apple was not a good investment. But if we are analysing the return since the 20th of September 2018, we discover that only Alphabet managed to provide a better performance than S&P 500.

Data Source:  Bloomberg

 

Europe

Data Source:  Bloomberg

The markets entered 2017 with the expectation of European equities to perhaps outperform their US counterparts, based mainly on the macroeconomic development and the position of the economic cycle. However, at the end of the year the expectation was not achieved as trade war fears, political developments and structural issues, surrounding EU weighted on the stock performance.

European stocks have encountered a slightly different dynamic than the US stocks, with the notable exception of the Italian and French indices, which managed to generate new highs during the summer, all other indices had a sideways movement and latterly a capitulation in the last quarter of the year.

The French Index managed to outperform its peers, as it has a lower exposure to financial sector and a lower industrial sensitivity to the US -China trade war.

The Italian Index made a new high in early May just to give back all the gains and to become one of the laggards in the region.

 

UK


Data Source:  Bloomberg

All indices have a had a negative return for the year. The Brexit negotiations, political instability and lack of support for the Brexit deal have weighted on UK equity performance.

In the FTSE 100, following the fall in February, it managed to make a new high in late May but as we approached the end of the year the negative news flow on trade war as well as the Brexit negotiation impasse, and finally the lack of support from Parliament, for the Brexit deal in its current form, stocks traded very heavily.

 

Entering 2019

With S&P 500 recording the longest bull market in history in 2018, we are entering 2019 at discounted stock prices. The selloff in equities over the last 3 months have brought the valuation of stocks below short- and medium-term averages but we are in the midst of a late cycle.

The Forward 12 months P/E, the ratio that compares the current price with the expected earnings over the last 12 months is well below the averages for most indices. The developed economies are expected to grow over the next year but that would not necessarily mean that equities would follow suit.

The FED monetary policy as well as the trade war and geopolitical tensions could prevent the crystallisation of the value opportunity that has been generated over the last quarter of 2018.

At this point news surrounding the US – China trade negotiation point towards a positive outcome but as the recent history has shown these positive developments can be fragile. 

In the UK, January should bring a vote by the Parliament of the UK separation deal. It is unclear at this point if the vote will be on the current or a revised deal. A tail risk event would be triggered by a no deal exist from the European Union, with high volatility during the period prior to the Parliament vote.

During November’s midterm elections, Democrats have won the House of Representatives. This opened the discussion of a potential impeachment of President Trump, especially after Michael Cohen, Mr. Trump’s long-time lawyer has been convicted for fraud and perjury.

In this environment with potential negative factor going to act against attractive valuation a wealth preservation strategy should be implemented.


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