There Will Be Growth in the Spring
Economic fundamentals remain positive
Corrections are normal in bull markets
City National Rochdale portfolio strategies have defensive tilt
2018 was the most challenging year for equity investors since the financial crisis. After climbing to a record high in September, a volatile fourth quarter left the U.S. stock market in the red for the first annual decline in a decade. The weakness was widespread, with nearly every global region and most stocks delivering negative returns. But it wasn’t only equities that suffered. The risk-averse mentality of investors pervaded almost all asset classes. In fact, last year was the first since 1972 when none of the major asset classes generated a total return greater than 5%.
For some time now, we have deployed a defensive tilt in our strategies. Our equity and fixed income research teams have made deliberate risk-mitigating decisions to help fortify client portfolios for later stage business cycle conditions and rising volatility, while also leaving them well positioned to take advantage of a continuing positive investment environment.
The degree of the recent sell-off in equities was surprising, even to us. In contrast, corporate bond markets were relatively, and reassuringly, resilient. Indeed, with stock declines toeing the edge of bear-market territory in December, we couldn’t help being reminded of the famous scene from the 1979 film Being There. Amid concerns about faltering economic growth, the movie’s main protagonist, Chauncey, reassures the President: “As long as the roots are not severed, all is well.”
Markets now seem to have regained some of their footing, though it may be too soon to call the recent correction process over. Trade disputes, tighter Fed policy, political uncertainty, and weaker global growth have created a more balanced ledger of risks than we’ve experienced in many years. Yet, amid all the worries, we too find reassurance in that the economy’s roots remain strong.
Market corrections can be very painful, trying the confidence of even the most hardened and seasoned investors. But it should not be forgotten that they are also normal. Since March 2009, we have experienced seven corrections, averaging a 13.0% decline. In fact, the recent drop is not uncharted territory for this expansion. Amid the Eurozone debt crisis and U.S. economic fears in 2011, stocks at one point fell 19.4%, only to rebound 33% over the next 12 months.
Similarly, we believe the fundamental investment backdrop today is more favorable than recent equity moves and headlines might suggest. Economic growth and corporate earnings may be slowing, but they are still growing and our most reliable leading indicators and SpeedometersSM are signaling that they should keep doing so for at least the next several quarters.
Meanwhile, we believe markets have now priced in much of investor anxiety. Based upon consensus expectations for 2019 earnings growth, the S&P 500 was trading at 14.4 times earnings at year-end, a meaningful discount from the 15-year median of 16.5. Other valuation measures, including the relative attractiveness of stocks versus bonds, also appear much more favorable.
The unsettled markets carrying into 2019 are reacting to new economic and political realities, and expectations for global growth and corporate profits are being recalibrated. Our rigorous investment process has led us to stay the course over this normal weighing process and not overreact. It may take time but, as we have seen several times before in this cycle, markets eventually reconnect to positive fundamentals. To quote Chauncey one more time, as long as the roots are well: “There will be growth in the spring” (and beyond).