Stock market confidence at a low.

Friday, 4th January 2019 14:36 - by Shant

The end of last year and the beginning of 2019 is pointing to a volatile year ahead, if not longer, as the financial markets have finally succumbed to the realisation that the post QE era is set to define a much-changed landscape to the one we have become accustomed to.  Many called this complacency and put simply, they were right.  Constant warnings of excessive valuations hugely divergent to the real economy were dismissed as scaremongering, but even the doom-mongers are right at some point in the cycle, and we are at that point - right now.  

Having first ignored the slow and steady process of quantitative tightening, we then saw a blind resilience to higher US interest rates, and again, the flattening of the yield curve offered little fear of what was to come ahead.  We could have described this has a car crash in slow motion, but accusations of hindsight usually tend to follow such projections, though the signs were there and were flashing red for some time.  Indeed, the first notable instance of sensitivity to financial conditions occurred when we saw 10yr US Treasuries hitting 3.25% just as the 30yr benchmark was eyeing a move on 3.50%.  Equity markets did not like this and at the time, we highlighted this as a significant flash point to consider down the line.  

Last month, contrary to calls for some restraint, the Fed chose to stick to its forward guidance and hike for the fourth time in 2018, and this proved to be a major catalyst for further losses on Wall St, which naturally reverberated through global stock markets.  Keen to display its independence from pressure from the White House, the Fed stuck to its guns and chair Powell has had to take it on the chin as a result.  In the aftermath, the markets have since downgraded their rate projections for 2019, from 4 to 2, though the futures markets are showing no changes through next year, while pricing in a cut by the middle of 2020!  

Looking at the Treasury curve, 2yr Notes are now just 2.41%, also reflecting positioning for a cut in the US inside the next 18 months.  Some market participants have started to call for a cut this year, though this reactionary change in stance is all too apparent these days and the Fed is far more inclined to signal an on-hold stance for the foreseeable future until the stock markets begin to stabilise and the economy shows signs that growth and expansion are at sustainable levels to weather current interest rate levels.  

However, this is just one part of the equation.  This week's market rout in Asia was said to have been sparked off by the revenue warnings from Apple, which pinpointed slowing demand from China.  If the US administration needed any evidence that protectionist policies in a globalised market are a dangerous game to play, then this is it, and any swift resolution to the US-China trade spat will now go some way to offer support to US stocks, though based on the underperformance in Europe, as much as the emerging market indices, better opportunities may lie outside of the US.  

There will be notable exceptions in the US, however, and standout are the energy and mining companies which have been hit the hardest last year.  Given that the strong Dollar has added an extra negative factor to commodities across the board, Oil prices have been hit hard by concerns over global growth more so that oversupply, as we now know that OPEC+ stand ever-ready to adjust production levels accordingly.  Shale producers in the US benefit from quick startup process and will complicate the process of market (price) realignment, but profitability at current levels is hard to come by so established names with sunk costs could offer some value in the near term.  

Concurrent with any stabilisation and/or pick up in the emerging markets is the prospect for infrastructure spending, and so value seekers would be better inclined to watch the mining companies.  Given growing anticipation for a lower Dollar, which looks increasingly likely considering a possible catch up with yield differentials, 2019 could be a better year for industrial metals, with the recovery in Gold prices - as well as the Japanese Yen (and how!) - showing the greenback likely to have peaked in the near term at least.  

I'm going to dust off the word 'differentiation' once more, and suggest that sectoral divergence will offer better opportunities going forward.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.