Year of the chihuahua
It’s been an eventful start to 2018 for global financial markets. The 5.6% rise for the S&P 500 Index was the biggest January gain since 1997. This rally was quickly followed by the first 10% market correction since early in 2016. With the strong rally followed by the large sell-off, the S&P 500 is off a mere 1.22% so far in 2018, but it feels like more!
|March ’18||YTD||1 Year||3 year||5 year||10 year|
|S&P/TSX Composite||– 0.49%||– 5.19%||– 1.16%||+ 1.03%/yr.||+ 3.80%/yr.||+ 1.42%/yr.|
|S&P 500 (C$)||– 2.00%||+ 1.73%||+ 8.40%||+ 9.13%/yr.||+ 16.39%/yr.||+ 9.63%/yr.|
|S&P 500 (U$)||– 2.69%||– 1.22%||+ 11.77%||+ 8.49%/yr.||+ 10.97%/yr.||+ 7.16%/yr.|
|MSCI EAFE (C$)||– 1.66%||+ 0.63%||+ 8.38%||+ 3.31%/yr.||+ 8.70%/yr.||+ 2.13%/yr.|
* Source: Equity Index and Currency Data: Bloomberg. Data as of March 29, 2018
2018 looks different from last year along a number of significant fronts:
- More fiscal stimulus from President Trump’s tax changes adding to already strong global growth momentum.
- New labour market inflation pressures with U.S. January payroll data triggering inflation scare.
- Central banks are becoming more hawkish, with the U.S. Fed likely hiking three times both this year and next and the European Central Bank preparing to wind down its quantitative easing.
- President Trump is turning out to be less protectionist than feared during his first year in office— although he’s now implementing tariffs causing fears of global trade wars.
This adds up to more market volatility and a complicated late-cycle backdrop for the market and for investors. My view is that, for now, the cycle tailwinds from synchronized global growth, strong corporate earnings and fiscal easing outweigh the growing headwinds from monetary tightening and inflation pressures.
I currently score this part of the stock market cycle as slightly positive for global equities, but I am watching closely for any signs of U.S. recession risk. The base-case analysis is that the most likely timing for the next recession is late 2019/early 2020. This means it’s probably another 12 months or so until recession risk enters the market radar.
From the standpoint of investor sentiment, equities were clearly overbought by late January. The subsequent market correction and partial recovery have taken most of the signals back to neutral. Overall, I recommend a neutral allocation to global equities, with a slight underweight to the U.S. that is offset by an overweight to both the emerging markets, Japan and Europe.
While the last part of March was the worst in two years for the stock market, the big question is: Will it continue? I believe the market will continue to be very turbulent, with a tug of war between positive and negative factors. This means stocks are likely to continue to rally and then sell off, with rotations in leadership among different areas of the stock market.
For those who celebrate the Lunar New Year, it is the Year of the Dog; for investors, it may be the Year of the Chihuahua. In 2017 and January 2018, the stock market’s spirit animal was the bull, a powerful force moving straight upward. However, I would argue that the stock market’s spirit animal is now the Chihuahua — a much smaller creature than the bull, but one that can make quite a bit of noise, jump up and down, run in circles and nip at investors’ heels. These small but mighty dogs can scare other animals that are far larger — but their bark is usually worse than their bite. Don’t be scared by the Chihuahua market. Embrace it and take advantage of the opportunities such fluctuations offer for opportunistic investors.
Given the potential for disruption and higher volatility, I believe investors may consider:
- Alternative investments which may react differently than stocks and bonds to market moves.
- Strategies designed to focus on lowering the volatility factor within equities.
- Actively managed strategies, in which portfolio managers have the flexibility to find opportunities and seek to avoid risks that they see in stocks.
- An increase in international exposure. While volatility has hit markets around the world, valuations are relatively lower in many markets outside the U.S
Given global economic growth remains near multi-year highs, earnings are expanding at a double-digit pace, and valuations look reasonable (particularly in international markets), I remain constructive on global equity versus fixed income and would view any material pullback in markets as an opportunity to put larger than necessary cash holdings to work.
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Senior Wealth Advisor
Director, Wealth Management
Mailey Rogers Group