After nine US rate rises and the steady dial-back of central bank quantitative easing, investors are now starting to feel the swell.
While US corporate earnings rose by more than 20% in 2018, thanks to tax cuts and a domestic growth surge, equity market multiples fell by even more. The result has been the first year of negative returns for the US market since the credit crisis and double-digit losses for Europe and Asia. For the first year in seven, US equity prices underperformed US corporate profits. Market valuations are normalising, but after a very strong 2017.
Thin holiday season trading volumes likely exaggerated December’s moves, but more frequent bursts of volatility across asset classes (we saw them in February 2018, too) will be a fact of investment life as monetary policy is regularised.
Central bank support and near-zero rates have kept equity volatility (measured by the Vix index) at an average of 15.3% over the past five years, less than three quarters of the average level that prevailed in the 20 years prior to that, so some normalisation is inevitable.
Typically, tighter money means lower valuations and lower real returns across all asset classes, so I fear 2018 was nearly ‘text book’ in terms of the market response.
We should be more concerned about rising bond spreads, which have now widened back to the levels we saw in mid-2016, with all of the tightening that resulted from president Donald Trump’s election and his ‘business–friendly’ agenda more than fully reversed.
The IMF, for example, is concerned that, while governments and consumers have reigned in deficits, absolute levels of corporate debt are still high (especially in Asia). The leveraged loan market in particular is showing that some excesses of 2008 are again re-emerging.
The shorter maturity segment of the US Treasury yield curve is gradually inverting, indicating that we are ‘late’ in the economic cycle and hence face a rising risk of recession. But it does not provide a precise timetable.
However, my growth worries are not in the West – where unemployment is low and consumer confidence and corporate profits are still robust – but in China. Economic visibility is poor, with manufacturing survey data now looking consistently weak.
Guy Monson (pictured) is the chief investment officer at Sarasin & Partners.