By Rebecca Ellis
Switzerland-THUR, NOVEMBER 01 2018-theG&BJournal-The US economy is still running strong, the financial markets should be humming along nicely. Leading US economic indicators remain favorable and consumer spending is strong. Instead, the markets corrected sharply in October: global equities are 13% from their peak, having fallen 9.1% in the past month. The recent market upswing notwithstanding, this latest correction presents a conundrum.
The Fed is looking at recent data and can only conclude that it needs to stay the course. For the economy not to overheat, the Fed needs to raise rates to keep in line with its inflation target. It has announced it will raise rates next December and three times in 2019. Trump has been considering tariffs on all Chinese products if trade talks fail. The market is now factoring in the damage that these tariffs will do to the US economy. The Fed rate hikes have an equally damaging effect.
Fundamentally most numbers look good. Despite some areas of weakness, earnings growth is still strong overall. For the S&P 500, third quarter Earnings Per Share (EPS) growth stands at 24–25%, with revenue growth of 7%. This will slow in 2019 as the year-over-year lift from corporate tax cuts rolls off, but we expect earnings growth to be positive: 4% in the US. The mood, however, remains quite volatile and a few minor misses in one or the other quarterly result, which is primarily due to high expectations, will send stocks spiraling off-course. In Europe where we expect mid-single-digits growth, the issues are mostly homemade: we have the Italian debt issue, Brexit, diesel gate and Monsanto-infected Bayer which are pulling down the indexes particularly in its largest market, Germany.
Valuations are now near or below long-run valuations after the sell-off. Based on the 12-month-forward P/E, the S&P 500 is trading slightly above its 30-year average, while international developed and emerging market equities are both trading near a 20% discount to their respective 30-year averages.
If it is ‘just’ a correction, the question arises, how long will it take and how deep can it go. Here, a look at history helps. On average, a correction in the US stock market takes four months and is down 13 percent. The current correction has only been in progress for five weeks, meaning that there could still be another leg down despite the depth of the current move. But even if it went a little deeper and took a bit longer, the good news is that, on average, you are likely to made whole again in just four months.
It could all end much faster if:
- the Fed softened its insistence on tightening regardless of the data and took notice of the looming dangers to the US economy and
- the US president could soften his intransigence on tariffs through a face-keeping ‘deal’
Then markets could great ready for the great year-end rally. These problems are man-made, and the leaders must be willing to change their mind. That is a big if: but something’s gotta give.
Rebecca Ellis is a Personal investment advisor, based in Zurich| REBECCA.ELLIS@POMOMAWEALTH.COM|PASCAL.CREPIN@POMONAWEALTH.COM
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