There’s a phenomenon in the investing world known as the Santa Rally, where stock prices rise in the month of December and often over the final week. But global equity prices have fallen sharply through this December, we take a look at why.
So far, in December, the US market (S&P500) is down by 10.6%. This follows a 6.9% drop in October and a 1.8% gain in November. Since 3rd October large US company share prices (S&P500) have fallen by 15.7%, while small US companies (S&P600) are down by 20.0% (Source: Bloomberg, Macrobond). This is of course a massive fall in stock prices.
For the first nine months of this year, US stock prices rose, whereas outside of the US prices started to decline from May onwards, which is quite an unusual divergence. Since the start of October, US equity prices are declining faster than in other markets.
So, what is driving this decline in US the prices? Quite simply, fear. Fear that the US economy is heading into recession in the very near term. We can see this from the way that the price of ‘growth’ company shares has performed versus more defensive stocks. However, if we look at what investment analysts expect from companies, so-called ‘bottom-up’ earnings are expected to grow by 15.5% percent over the next 12 months – hardly a recession. Moreover, if we look at the evolution of analysts’ forecasts for 2019 earnings, through the course of 2018, expectations have not changed substantially since 3rd October (-1.8%) and the level of earnings expected in 2019 is the same as it was in early July – when the S&P was 10% higher.
As such, the valuation of US companies has collapsed, compared to what analysts forecast earnings to be in the future. If we look back at the history of the market since the 1980’s, US stocks have suffered the second largest devaluation of equities during a year, more than in 2008. As the chart shows, most these devaluations have happened during recessions.
So, this very large fall in US stock prices only makes sense if the US is heading into a recession in 2019. But the consensus forecast for US economic growth in 2019 is currently 2.6%, only slightly down on 2018 and faster than 2016 and 2017. This could, of course, be wrong, but current economic statistics do not point to a serious slowdown in US activity.
When fear grips investors, markets can fall very sharply. However, focusing on the longer-term picture, particularly on how the economy and companies are performing, is a better guide to the future performance of stocks – even if the journey can be a very bumpy one.
As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past or future performance indicators are not a reliable indicator of future performance.