The Bull Market May Not Be Over – But Solid Fundamentals Matter In A Time Of Uncertainty
Byline: James Norman, President of QS Investors
April 16, 2018
As the calendar turned from 2017 to 2018, equity markets were flying high. In January, there was no reason to be anything other than enthusiastic, perhaps too much. And then, of course, the markets – and history – came back.
The first downturn came at the end of January, spurred by overreaction to fears of inflation. This was followed by a decrease in February and an up and down, aimless March.
Volatility returned with a vengeance, the VIX index1 increasing 80 percent over the quarter. Investors moved in herd-like fashion from complacency back to historical volatility and higher, becoming more defensive on concerns about economic growth going forward.
The 2Q2018 outlook is little better. Fundamentals continue to look good, including earnings estimates. However, as the U.S. bull market turns nine, we expect economic growth to slow down this year. The main factors likely will be broad interest rate headwinds and trade policy uncertainty, including the potential for a tit-for-tat trade war.
Some key economic data also have softened, such as global trade, manufacturing indices and new orders.
But: The recent sell-offs of many large U.S. tech companies (Amazon, Facebook and Netflix chief among them) has caught our attention. This handful of stocks led the market higher in 2017 and early 2018, dramatically outperforming it. Investors have become concerned over these tech giants’ lofty valuations. Many of these companies are now facing potential regulation, political scrutiny and enhanced competition that could make meeting previously soaring expectations difficult. Investors are reasonably concerned they paid too much for outsized future growth that may not materialize.
When it comes to the nascent “trade war,” the new Chinese tariffs (both on and imposed by them) are unlikely to have much impact – if the war goes no further. What the markets are really watching is whether this is just the first step in an escalating trade war that could dampen global economic growth. The Trump Administration has proven unpredictable, so time will tell.
Investors should take heed of trade announcements related to tariffs and negotiations on major trade agreements, particularly NAFTA, and any major economic indicators that show weakening.
In consideration of investment strategies, data from the U.S. and globally suggests optimism that this historically-long-running bull market can continue, tempered by healthy caution. Late-cycle behavior may be setting in: higher volatility; investors questioning market valuations of the names that went up most; and growth outperforming value by so much that 2017 saw the largest outperformance since 1999. Taken together, it may make sense to rotate from growth to value – if we are having a potential slowdown and eventual recession, as investors tend to pay more for value, quality and steady income.
We believe defensive equity income strategies – which are value-oriented – will outperform. Investors should be attracted to their generally stable earnings and dividends, cheap valuations and smaller historical drawdowns in down markets. A little defense in times of turmoil can be a good play.
James Norman is President of QS Investors, a subsidiary of Legg Mason. His opinions are not meant to be viewed as investment advice or a solicitation for investment.
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