Best Start Since 1987

Posted by Ethan Dang

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It is always darkest before dawn. The fourth quarter of 2018 was full of market uncertainties and concerns, such as U.S.-China trade tensions, that gripped the global markets. Financial markets are forward-looking, forecasting machines; as a result, many of the risks were being priced into the markets during the corrective phase. From peak to trough of the correction, the S&P 500 declined about -20% and the TSX dropped about -18%. Despite the negative market sentiment, the underlying macroeconomics and fundamentals remained sound and stock valuations had returned to a more reasonable level. After the correction low was put in on December 24, 2018, investors went shopping on Boxing Day and delivered 5% and 3% gains for the S&P 500 and TSX respectively in a single day. The ensuing rally has been relentless, producing a V-shaped recovery and bringing the S&P 500 and TSX within 5% of their all-time highs. This rally has been impressive even by historical standards, producing the best start to the year since 1987.

Just as uncertainties and fear took hold of the markets last Fall, we have seen those concerns alleviated by various developments in 2019. Let’s take a look at the key concerns and see how they have been addressed.

Concern #1: Slowing Global Economic Growth

  • Counterpoint: 2019 Forecasted Real GDP Growth*: U.S. = 2.5%; CA = 1.9%; EU = 1.5%; Japan = 1%; China = 6.2%; India = 7.2​
  • Takeaway: Despite slower economic growth compared to previous years, major global economies are still growing at a good pace on aggregate and corporate earnings remain strong.

Concern #2: Fear of Global Recession

  • Counterpoint: 2019 Recession Probabilities for major economies*: 15% to 25%
  • Takeaway: Although economic recession probabilities are not insignificant, they are relatively low for 2019. Yield curve inversion, which has been a reliable precursor to recessions, has not occurred.

Concern #3: Tighter Monetary Policy (central banks hiking interest rates)

  • Counterpoint: U.S. Federal Reserve reversed their aggressive stance on interest hike rates from December 2018, expressing a patient and data dependent approach. In Canada, just one rate hike is expected in 2019, while Japan and the Euro Zone are expecting no rate hikes this year.
  • Takeaway: Accommodative central banks are a tailwind for the markets. Slower rate hikes are favourable for businesses (lower cost of borrowing) and consumer spending (more disposable income).

Concern #4: Heightened Trade Uncertainty (U.S. vs. China trade war)

  • Counterpoint: If President Trump wants to win the next U.S. election in 2020, he is likely to release pressure on the trade conflict at the maximum point of leverage to maintain confidence in the U.S. economy.
  • Takeaway: Trade uncertainty remains a pending issue and is the biggest risk for global markets, but it is likely a transient concern when viewed through the lens of politics and game theory.

*Source: Bloomberg

Given the extent of the rally from the Dec 24th low, it would not be unexpected to see a short-term pullback or consolidation develop in the markets. However, from a charting perspective, most North American stock indices have now moved back above their respective 200-day moving average, which is an important technical development and a sign of strength in this recovery. The odds of a retest of the December 2018 lows have decreased. 2019 is proving to be an interesting year for the markets, like every other year!

Ethan Dang, CFA, MBA is a Portfolio Manager at McIver Capital Management at Canaccord Genuity.

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