Stock Market and Economic Outlook 2019

The final quarter of 2018 was subject to an unusually high number of negative forces which created a perfect storm for financial markets. The determination of the Federal Reserve to “normalise” US short term interest rates, ongoing trade spats between the US and China, fears about European and Chinese economic weakness, the Italian budget dispute and Italian debt (Italy is the third largest government bond market in the world), the US government shutdown and last, but certainly not least, the ongoing Brexit negotiations all played their part in undermining investor confidence. The response was a series of market jitters. The MSCI World equity Index fell by 5.4% in sterling terms in October and after a brief rally in November, this was followed by a fall of 7.4% in December. It was the second worst December on record for stock market investors.

Market Commentators frequently referred to these falls as “turmoil”, but stock market history suggests that falls of this magnitude are more normal than people realise. A better example of what might reasonably be described as market turmoil was the so-called “Black Monday” on 19th October, when the Dow Jones Industrial Average Index fell more than 20% in a SINGLE day. That was indeed traumatic.

It is also true that falling stock markets are part of the regular stock market cycles we have always seen. In fact, stock markets that don’t have periods of falling prices are incredibly abnormal.

But 2018 is behind us and most investors are, quite rightly, now asking ‘where do we go from here?’. Financial markets have already regained some of their poise in January having recovered from the December lows. Indeed, a negative year makes forecasting both easier and more certain because, using Stock Market history as a guide, two successive negative years have only ever happened during either a global recession or a world war. We at Clarion do not expect either of these events to occur in the foreseeable future.

Even if there is a panicky new plunge to test the stock market lows of Christmas Eve that some commentators may call a bear market, it is unlikely to matter, as corrections and bear markets usually end after the super sharp falls of the type experienced in December. Using the US’S S&P 500 index since 1925, stock markets have averaged a 12.4% gain in the years following a negative year.

Many market commentators believe that the bad times will remain, but the falls in 2018 were sentiment driven and theories abound as to what drove the ugly returns; to paraphrase Albert Einstein, ‘theory can be distinct from actual reality.’ The pessimists ignore the positive economic backdrop with employment at multi year highs and purchasing managers indices showing continued growth in December with forward-looking orders expanding. When the politicians finally get on with Brexit, the fog will clear.

Global growth also continues. Commentators worry about high-profile weak spots but only five developed nations contracted in the third quarter of 2018—Germany, Italy, Sweden, Switzerland and Japan. Together they are just 14.5% of Global GDP. The growth of the other 85% more than offsets the laggards and many of their issues are temporary, for example the European Auto Industry’s backlog for new emissions standards and Japan’s natural disasters.

Meanwhile, global lending and money supply keep rising, fuelling investment. The growth in the M1 measure of the money stock in Europe and the UK is accelerating. This is a good lead indicator as accelerations in money growth in 2001-03, 2008-09 and 2012-15 all led to faster economic growth. When companies and households plan to buy big ticket items, they will move their assets from illiquid forms (which aren’t part of M1) into liquid assets, which are part of M1. Also, if readily spendable cash is rising for any reason—because incomes are rising—most people will be tempted to spend more. Either way, monetary growth is a reliable predictor of output growth. Of even more significance is the Conference Board’s Leading Economic Index series which is high and rising globally. This is one of the most reliable forward economic predictors available and it is rising for almost every major country.

Stock Market reaction to the negative sentiment in the final quarter of 2018 is bound to leave investors bruised and further volatility is certain to follow. However, we at Clarion are cautiously optimistic that we are unlikely to see another down year in 2019, always accepting of course that stock markets can be remarkably fickle being driven by the contrasting sentiments of greed and fear. With markets already off to a positive start we look forward to a more rewarding 2019 with better returns across the board.


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