FYI | Nov 07 2018
By Peter Switzer, Switzer Super Report
Bull market or a crash? The outlook for equity markets
Are we really in a bull market? And given the pretty lacklustre year that equity markets have had in 2018, are we poised for a crash? This was the substance of an email I received last week from a fellow subscriber and because a good answer required a fair bit of analysis, I promised to turn it into my piece for today.
To put you entirely in the picture, this was Sandy's email, tidied up by my sub-editor, no doubt.
"Peter, why do commentators like Alan Kohler in The Australian, for example, continually talk of a bull market? The ASX has performed quite modestly over the last 10 years, never getting near pre-GFC highs. So I must be missing something.
Another thing, with the world appearing to be reasonably stable, with few real or new crises etc., almost all world indices are down on a year-to-date basis. Why?
"And apart from the US, they're generally down not from their tops. I thought our economy and the world economy were in reasonable shape. So why have world stock markets been so tragic? Are people tired of equities? Maybe some year soon we will see a 25% goer for the ASX to get punters back engaged! (I always enjoy your product and commentary — excellent!)"
These are great questions sent by our subscriber and worthy of examination.
Potential threats around the corner
The bull market issue is both simple on one level but gets complicated, depending on what definition of a bull market you want to work with. I prefer the one that says the bull market started in March 2009 and there has been no sustained 20% fall of stock prices that signal that a bear market has started. The latest sell off would be seen as a correction — a 10% sell off — and the huge volatility it came with made some commentators ask if a bear market is looming.
I mentioned recently that Citi's bear market indicators study has only 4 out of 18 waving the red flag, so that makes me relatively comfortable that a bear market is possibly one, but more likely, two or more years ago.
That's based on what I can see. If I took black swan events on board that could cause a 20% plus sell off of stocks and by definition, they are unseeable, then I'd say there are numerous potential threats out there to Wall Street, which then could spread to our S&P/ASX 200 index.
Clearly, the antics of Donald Trump with his trade war with China, other Trump issues, such as the growth of the Budget Deficit in the US, his willingness to bag the Fed for raising interest rates too fast, his willingness to get involved in geopolitical matters with economic implications, all potentially could trigger a big stock market sell-off.
The Saudi killing of a dissident journalist and the sanction on Iran both have possible oil price implications. And encounters with Turkey, Syria, Russia and even the EU, show how Donald is a possible black swan creator waiting to happen.
Throw into this analysis that there are cyclical bull markets and secular bull markets and this bull market analysis gets more complicated. Gary Stone of Sharewealth Systems thinks the secular bull market started later than 2009 and has legs that could go for many years after 2020 or 2021, which I reckon the majority of market commentators think will be the dangerous time for US stocks.
Then interest rates will be much higher, economic growth could be falling from historically high levels and the US Budget Deficit will be peaking and worrying more market experts, who influence the likes of Wall Street.
Also another US election would be out of the way and markets will have to deal with another term with Donald or the absence of this unique US President. He could be missed for his stimulus and markets might find a new regime less helpful for big business. Who knows?
I won't go into this here but people like Gary tell you there are shorter cyclical bull and bear markets inside a longer secular bull or bear market, but right now we are in a cyclical bull market, though at times it might not feel like it, inside a secular bull market.
Uncertainty on many fronts
The current malaise for many markets this year is linked to the following:
• Many markets are off all-time highs, unlike us. This chart looks at the German Dax Index since 1987:
It's had a rough year lately but it was at all-time highs. The Yanks are off all-time highs but the French are a bit like us, having not quite beaten their old record highs. We had a mining boom collapse to deal with and they had the EU troubles and their own in-house issues, which have impeded the growth of their stock market. And the Poms, even with Brexit and PM problems of an Australian-kind still were at record highs!
• Trade war concerns and the impact on Chinese economic growth has hurt Asian stock markets and has taken the gloss of US markets, as some big American firms are significant exporters to the US. Also, a stronger US economy has driven up the value of the greenback and led to capital or simply money leaving emerging economies (EEs) heading for the States. This hasn't helped EEs and their stock markets.
• Trump's trade war rhetoric instantly affects Wall Street. Last week, there was talk of a trade deal with China and we had our best week since November 2016. And that was around when Donald was elected! Seriously, his fingerprints are over so many market-moving matters!
• The EU has issues like Italy not playing ball on their budgetary obligations. And there's even Italy-exit issues floating around. This has coincided with a slowdown in the Eurozone. I reported on Saturday that the Eurozone economy grew by just 0.2% in the September quarter (forecast +0.4%) — this was the slowest pace in four years! That said, the consensus view is that Europe will see an economic bounce back and I bet it will line up with an eventual US-China trade deal. Remember, Trump is making his trade plays for both political and economic wins!
• The US stock market is the most advanced in terms of valuations and the big drivers — the FAANG stocks and a few other tech companies, such as Microsoft — have seen huge valuation spikes. Some like Facebook have been stripped of 30%, so it's in a bear market, which helps to explain the market negativity around now. But it also sets the US market up for a rebound, when say Trump negatives become Trump positives.
• There's a midterm election this week in the US. What this means for the Trump Presidency has added uncertainty to markets and helps to explain this ordinary year for stocks. The second year of a four-year presidential cycle is historically the worst for stock markets and then October for a variety of reasons can be troublesome for stocks.
• On the local front, we've had a huge mining boom fizzle out, our stock market did better than the Yanks from 2001 to 2007 before the GFC, so we're finding it harder to come back from the 50% market collapse, we don't have FANG stocks, we have had political instability and our best trading partner, China has been economically slowing down. Then on top of that we've decided to make out banks safer via the Murray Financial Inquiry and then the Royal Commission has made them more honest, less profitable and tougher with handing out their loans. And now the housing boom is going off the boil and media outlets are running with the scariest scenarios out there at the expense of objective reports, which say the property drop will be more a correction than a crash!
Positives and negatives
I think in 2019 we'll see our market creep over its all-time high and my longed for 7000 will show up. However, I'll be on the lookout for signs that the strong US economy, with its great company profits, is in more trouble than has been predicted.
The third year of a presidency is good for stocks and I suspect Trump's Republicans not being KO'd at this week's midterm election followed up by a China trade deal would be great for setting up next year for a stocks rebound. But this positive outlook for stocks has to deal with so many moving, controversial parts out there, linked to unpredictable types like Donald, Italians, EU leaders, Iranians, OPEC, Brexiteers the Labor Party's property and retiree policies and Australian voters, it's hard to be 100% positive that amongst all these people and issues that one doesn't morph into a black swan.
I hope I'm wrong on a potential black swan out of that lot above and that I'm right that 2019 will be good for stocks. But as I always say, hope isn't a strategy. That said, I'm fully invested to benefit from this latest sell off.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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