Market Outlook Q4 2019 - More upside ahead

The global economy is in better shape than the headlines would have us believe. The more than 25 global interest rate cuts since May 2019 together with fiscal stimulus measures should accelerate global growth. Yet, geopolitical risks are here to stay but when the headlines scream ‘sell’, hidden gems tend to surface.

We expect the fire brigade to arrive in a split second when we see smoke. In the third quarter of 2019 we saw the largest number of interest rate cuts by central banks over a three month period since the Great Financial Crisis of 2008/2009, in the same way that firefighters need to isolate a fire in a field so that the surrounding fields can prosper. These rate cuts are a shot in the arm to the world economy and should support consumer spending and help reduce the adverse impact of the uncertainty created by the US-China trade conflict. Thus, central banks are flooding the world with liquidity, which is laying the seeds for some shoots of growth early next year.

As of 30 September 2019. Source: Thomson Reuters Datastream, Julius Baer Economics Research.

Central banks have now embarked on a recession-fighting mission. This should support both economies and markets in the months ahead.

Christian Gattiker, Julius Baer - Head of Research

Our outlook for markets – a bird’s eye view
Back in the summer, market participants fled into safe-haven assets, as exemplified by the more than USD 17 trillion in negative-yielding bonds globally. However, meaningful interest rate cuts in the face of excessive investor pessimism tend to be followed by the outperformance of riskier assets, particularly if they help to ignite growth as we expect them to. This drives the case for investing in equities and taking measured credit risk in the fixed income space in the months ahead. However, growth will not be equally distributed and thus, the environment remains attractive for stock-picking strategies.

Where are the sweet spots in the fourth quarter?

  • Equities:
    • Style: Value and cyclical stocks
    • Sectors: Communication and information technology
    • Emerging markets: China and Brazil
  • Fixed Income:
    • Developed markets: Low-investment-grade bonds, better rated high-yield bonds
    • Emerging markets: Hard-currency investment-grade bonds

What do equity investing and skiing have in common? Your style needs to be adjusted according to the conditions
In skiing, we adjust our style depending on the condition of the slopes - sometimes the safety first principle requires us to slalom down the hill, while at other times we can increase the speed and get into a downhill position. Similarly, in equity investing, a particular investment style, such as ‘growth’ or ‘value’, may be more appropriate, depending on the current state of the market.

Growth investors look for companies that exhibit above-average growth, such as in earnings. Many are highly valued relative to a fundamental metric (such as this year’s earnings) given their (earnings) growth potential. On the other hand, a value stock is a company trading at an attractive level relative to a fundamental metric. Once market participants realise that a stock offers good value, investors scoop it up and the stock price rises. To quote Warren Buffet on the subject of value investing: “Price is what you pay, value is what you get.” 

Currently, value stocks are trading at a record discount to growth stocks. Thus, we would expect value stocks to outperform in the coming months, if history is any guide, with the likely catalysts being stronger growth and higher bond yields given the cyclical tilt of value stocks.

As of 31 August 2019; based on month-end data. Source: Thomson Reuters Datastream, Julius Baer Equity Research.

When it comes to stock picking, a value stock may remain undervalued for a reason, while a growth stock may never deliver on its growth promise. Thus, we asked our Head of Equities Research, Philipp Lienhardt, how his team aims to reduce the risks associated with value and growth stocks.

  • For value stocks, he notes that the team looks for triggers that could close the valuation discount. Such a trigger might be a company presenting a compelling long-term strategy or financial results that beat market expectations. In some cases, a spin-off of an underperforming asset can serve as a catalyst.
  • Some growth stocks, on the other hand, may reflect high expectations and thus have lofty valuations, Philipp Lienhardt said. In this case, a slight miss can lead to a sharp share price correction. Thus, he notes it is important to separate the wheat from the chaff.

Taking a step back, the MSCI World Index has risen by 9.4% p.a. this decade (140% in total). Looking closer, the average stock has returned ‘only’ 7.7% p.a. (105%). However, stocks that have been rising this decade have returned on average 12.2% p.a. (220%). Thus, the ‘winners’ have won by a large margin, illustrating the fertile environment for stock-picking strategies.

Key takeaways

  • Investing in equities and taking measured credit risk should pay off as global interest rate cuts are laying the foundation for an increase in global growth early next year.
  • Global economic momentum is not equally distributed, thus investors should focus on stock picking to gain exposure to the most promising opportunities.
  • Value stocks are too cheap to ignore, while growth stocks should be in every portfolio.

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