The end of the year is already drawing nigh on stock markets: it is true that trading will continue during the coming week, but trading hours are going to be shorter. The DAX is likely to end the year 18 percent lower, while the annual price loss for the Euro Stoxx 50 should amount to somewhat more than 12 percent.
To find a worse European equity-market year, we would have to go back as far as to 2008. In the political and sporting domains, 2008 was not, admittedly, a particularly exceptional year – Angela Merkel was already Germany’s Chancellor and FC Bayern München finished top of the Bundesliga. In the USA, George Bush Jr. was the incumbent president and Blackberry devices were the state of the art for corporate telecommunications (there are said to definitely still be people who wish this era would return). In capital markets, however, 2008 was the year in which the financial crisis peaked – the VDAX surged to as high as 85 points and the economy was already mired in a deep downswing.
2018 has been a year which has set a whole host of negative records for equity markets. Since the high marked on 26th January, the market capitalisation of global stock exchanges has shrunk by more than USD 14 trillion (or 15 percent); what is more, 2018 will probably prove to be the first year since 1994 in which cash generated a better return than either equities or bonds. A comprehensive assessment of asset classes on an US dollar basis reveals that 50 out of 70 are in negative territory in the year which is now coming to an end; historically, only one in four asset classes ends a year lower than it started.
The situation on equity markets is likely to ease again in 2019, but not straight away at the outset of the year. The trade standoff between the USA and China, patches of weakness in Brazil, Argentina and Turkey and, to top it all, the uncertainties surrounding Brexit and the budget spat between Italy and the EU amount to a decidedly ill-tasting cocktail. This predicament is being compounded by the structural challenges facing the German automobile industry and by sagging operating results at individual DAX companies. In response, Germany’s largest corporations have produced a whole slew of profit warnings over the second half of the year. DAX earnings are likely to have declined by around 8 percent during 2018. A turn for the better is going to take some time in coming.
If the various crises do not escalate any further, the DAX ought to climb back towards 12,000 points in 2019, with the S&P 500 headed for the 3,000 mark. Market sentiment is decidedly negative, and yet there are no indications of an imminent recession. Despite regional problems, global economic growth remains on track at 3.6% percent. Corporate earnings ought to still increase to some extent both in the USA and in our part of the world, which will help stock markets. Another plus point for equities is the disappointing real rate of interest, which means that bonds are no alternative.
Apart from political risks, rising capital-market interest rates in the USA are the biggest danger for equity markets looming in the medium term. The threat here is the boiling frog syndrome – higher interest rates have the same effect on borrowers as water slowly reaching boiling point does on a frog sitting in a pot of water: the rising temperature is not disturbing at first, but at some point the water is hot enough to have grave consequences. Companies, and emerging markets, will be downgraded by rating agencies and will no longer be able to repay interest on loans, with weak corporations possibly becoming insolvent. Equities will become more unattractive relative to bonds. In individual cases, there will be a good deal of pain, but the process should nonetheless prove a relatively mild one at a macro market level. This is because US yields ought to climb to a less pronounced extent than in earlier cycles, or because the Fed will take countermeasures, reversing its rate-hike cycle if an escalation is threatening. All the same, a slowdown in earnings growth is still to be expected.