The outlook for European stocks appears more mixed than a year ago -- with similar potential for both very good and very bad outcomes based on the macro environment.
Investors should take some comfort from the fact that valuations are much lower now than at the start of last year.
The question in 2019 is whether global economic growth will continue to slow down or even halt with corporate earnings materially affected, or will we see this year as the culmination of a soft patch for growth and a great opportunity for equity investors.
In the past few years, our outlook has generally been constructive towards European equities. In 2019, we have a more balanced view, as this year is likely to be either very good or very bad depending on how the macro environment develops. The year may be the proverbial game of two halves, with the first six months being highly uncertain and volatile as the market sentiment swings around depending on incremental data. If the market materially corrects, this could present a great opportunity for the second half.
Here are our range of likely outcomes for European equities this year.
Bull Market 40% likelihood
This would involve markets remaining cheap and the ‘Goldilocks’ scenario of growth plus low inflation playing out in 2019, which would be supportive of risk assets. The opportunity here would prompt us to favor quality industrials and mid-cap growth companies which exhibit strong business models, high barriers to entry, value creation -- and that were overly de-rated in 2018.
Trading Range 20% likelihood
Markets could rebound in early 2019 given they became so oversold in late 2018. With deteriorating global economic growth in early 2019 the market upside is likely to be limited and equities trade within a 15% range. Under this scenario we would reduce exposure into rallies and buy into weakness until there was clarity on the direction of the economic cycle and central bank policy.
Bear Market 30% likelihood
The Fed will be seen to have over tightened, global growth suffers more than expected, deflationary pressures re-appear. Risk assets including European equities perform badly.
Eventually the Fed cuts interest rates and stops reducing its balance sheet. Should this happen, we would favor a low, or short, net exposure until the credit and macro indicators stabilise. Positive returns will only be generated from short positions where the focus would be companies with high operational and financial leverage. As the huge majority of share prices fall and de-rate, the long positions will aim to outperform the index.
Collapse 10% likelihood
As we have mentioned in previous outlooks, the bear market outlined above could become a full-blown crisis with a breakdown in global trade, debt defaults and/or the break-up of the European Union. Opportunities to short will be high, with many stocks falling dramatically and many requiring refinancing. We would view a net short exposure as appropriate until all central banks begin returning to materially expansionary policies.