The final quarter of 2018 was one of the worst quarters for global equities in 45 years. In the past, such performances have usually only occurred in periods of recession and oil shocks. It is highly likely that 2018 was the year that earnings growth peaked in the current global equity earnings cycle. But is the world close to a recession that will adversely impact markets?
NN Investment Partners (NN IP) believes that global economic growth will remain solid and around potential, but still slow relative to 2018. NN IP expects that global earnings will fall from 16% in 2018 but remain positive, delivering a global equity return of 5%-7%. The decline in earnings will be driven primarily by the fading impact of US tax reform on US earnings and an economic slowdown. Higher wages prompted by a tight labour market could also place some pressure on profits.
Valuations have already fallen significantly, limiting the downside. The valuation of global equities has seen its biggest fall since 2011, and the 12-month forward PE ratio is around 14 times, illustrating the extent of the market decline. However, NN IP accepts that there is a wide range of possible upside and downside outcomes.
Patrick Moonen, Principal Strategist Multi Asset, explains: ‘We expect moderate positive returns in 2019, driven by modest global earnings growth. Macro convergence and monetary policy normalization are two important themes that will determine our gradual shift towards non-US equity markets and our preference for financials and commodity cyclicals over the bond proxies. Short-term political uncertainties linked to trade protectionism, Brexit and Eurozone politics keep us wary and limit our conviction levels.
‘Political risks will be key in 2019. The number-one risk is the trade war between China and the US, which has started to affect the corporate outlook and confidence. There is currently a truce until the end of February, which allows both parties to continue discussions. A positive outcome here is crucial for investor confidence and the growth outlook.
‘In addition, the chaotic Brexit process has entered its final phase. The deal proposed by Prime Minister Theresa May was rejected by Parliament in a record-breaking defeat, and while the government survived the vote of no confidence that followed, it appears to be no closer to finding a deal that will satisfy Parliament or the electorate. Various options remain, including a no-deal Brexit or a revocation of Article 50, but time is running out. Given the stakes at play, it is possible that the UK and the EU will try to prevent a no-deal scenario and would rather elect for a postponement.
‘Regarding monetary policy, we expect the Fed to pause any further rate hikes for the next 5 or 6 months. For the year as a whole we think the Fed will hike twice, but this will remain dependent on the underlying data. We expect some moderate upward pressure on bond yields and spreads. The reduction of the gap between the cost of equity and the cost of credit, increased corporate leverage late in the cycle, and the absence of a cash repatriation wave may cool companies’ appetite for buying back their own equities, which was a major source of equity buying in 2018.’