By Maarten Ackerman, Chief Economist and Advisory Partner, Citadel.
The cracks may be starting to show in the ten-year equity bull market, but does this mean that the cycle is now over?
Global equity markets – and the US in particular – have enjoyed one of the longest post-WWII bull runs. Starting after the global financial crisis of 2008/9, equity markets have shown a steady upward trend until recently.
While economic growth around the globe in 2018 was sound, leading to solid company earnings, markets bucked the trend, decoupling from the stable economic fundamentals and anticipating weaker times ahead.
While the long-term bull market remains intact for now – the pullback in global markets does signal weakness. The question is a matter of when, rather than if, the trend will end.
At Citadel, we believe that most economies will still deliver reasonable growth during 2019. Clearly, there are headwinds facing global economies this year, with geopolitics playing a major role. Brexit, for example, is already in uncharted territory and will certainly be messy, while populism is taking hold in Europe. In France, the “yellow vests” have thrown the country into turmoil, and the US-Sino trade war remains unresolved. However, there remains capacity for positive growth in 2019.
Although the Chinese economy is already slowing down, the authorities are planning for stimulation to support it and engineer a soft landing. Such a move would be positive for emerging markets, which are reliant on a healthy China, and we expect the Asian giant to come through for them.
Across the Pacific we see the US also showing somewhat slower growth this year, but there will be some fiscal support for the economy and we are hopeful that a trade agreement will be reached between the US and China which will benefit the markets in general.
Tougher economic environment priced in by the markets
Using a basket of ten economic indicators, we see a low possibility of a US recession in 2019. Although the pace of economic growth is slowing, it is still expected to remain positive, leaving expectations for company earnings in comfortable territory. The likelihood of a recession however increases significantly going into 2020.
The market has already priced in the weaker economy and, coming from a low base in 2018, we expect equities to rebound over the course of 2019, with upside potential still on offer to investors, although in a more volatile environment. Rather, a tougher year is more likely to materialise in 2020 when the US will need to negotiate higher interest rates and growth disappointments in an election year. A recession could even be a possibility then, with a dismal US equity market to match.
A slower interest rate hiking cycle in the US and a possible breather by the US dollar would, alongside support in China, also be good for emerging market economies and currencies.
SA has the scope to improve …
South Africa is exiting a technical recession and growth for 2018 will be muted. Consumers face enormous headwinds in the form of a stubbornly high unemployment rate, VAT at 15% and interest rates on their way up. But at the same time, we have a new political administration that is slowly making headway in turning the economy around.
Much will, however, be on hold until after the May 2019 election. Until then, political jockeying will consume politicians and the electorate alike and attention will be focused on issues such as land expropriation without compensation (EWC), service delivery and state capture.
We are unlikely to see any meaningful progress towards economic policy reform until the ANC, and notably president Cyril Ramaphosa, receive a solid mandate from voters to enable government to concentrate on the business of governing.
Once there is sufficient clarity and motivation to attract local investors, foreign investors are expected to follow.
… but will it?
There are, of course, risks to this scenario. The South African economy retains its extensive structural defects and holds many challenges – from an excessive debt burden, to a floundering power supplier, to almost insurmountable unemployment. It is perhaps wrong to view the outcome as binary, but if things do not fall into place as envisaged, 2019 will prove another tough year for the country.
As far as the financial markets are concerned, we foresee a year of greater volatility on the back of the heightened geopolitical uncertainty, as well as the outside chance of a bear market.
Against this backdrop, we are following a defensive strategy for 2019. We have increased the amount of shock absorbers – such as hedge funds of funds, protected equity and defensive stocks – being held in our portfolios and we are reducing exposure to sectors that are vulnerable to market volatility.
At this stage we view global equities as offering better prospects than South African counters, especially Europe and Japan.