Candriam: US stock; sudden technical sell-off, but the fundamentals hold. Three possible scenarios for the US for the 2018-2019

(by Nadège Dufossé, CFA, Head of Asset Allocation by Candriam Investors Group) Since last week, stock markets have burned most of 2018's gains. The stock exchange start-up in January had been too rapid and the sentiment indicators had become overly optimistic. However, the market sell-off is more systemic than based on fundamentals. The growing fear of investors that the so-called scenario of Goldilocks is about to close is unjustified and, in our opinion, a context of favorable fundamentals will eventually prevail.

Since the end of last week, equity investors have begun monetizing their 2018 earnings, initially because they are worried about a possible end to the Goldilocks scenario, and in particular, a sudden flare-up in US inflation. However, the real reason behind the sudden crash in the US stock market on Monday was a technical sell-off, not an inflation-related fear, as demonstrated by the decline in bond yields during the equity sell-off. It was the result of a systematic sale and repurchase of large short positions on the Volatility Index (Vix).

 Evaluation of inflation risk and scenarios

A far more solid expansion of the expectations recorded a few weeks ago, a renewed weakness of the US dollar and rising commodity prices are just some of the many reasons for fear of a return to inflation. After almost a decade of uninterrupted deflationary surprises, the general view of a continuation of inflation below the trend is faltering. We agree with the Fed that this year US inflation should increase.

The US cycle is the most advanced globally - as evidenced by the unemployment rate - and has received further stimulus from tax reform. This caused perceptions to change rapidly. Since the end of November, XNUMX-year Treasury bond yields, driven by expectations of rising inflation, have risen sharply. However, US real yields remained extremely low, offering strong support for the economy and equities.

 Candriam provides three scenarios for the 2018-2019 in the United States:

  • Main scenario (60% probability)

The US bond market finally realizes that no recession is coming and quickly adapts to the Fed's path of three rate hikes for this year and three more in the 2019. In part, rising bond yields are more in tune with the increase in the value of equity securities. Looking ahead, we expect further normalization, but without it Overshooting, with the yield of US government bonds to 10 years that could reach 3% in 2018, thanks to the strength of the expansion.

  • Investment boom and return to productivity (15% chance)

The tax reform leads companies to invest more permanently (+ 10% in both 2018 and 2019) with a strong increase in productivity. In this context, inflation remains subdued and the Fed abides by its plan. Equity markets continue to grow, supported by earnings increases. Long-term rates increase as the rate of potential growth increases and do not cause the economy to slow down.

  • Fear of inflation and falling equity markets (25% probability)

The markets suddenly realize that the Fed is behind the curve and begin to fear a surge in inflation: long-term interest rates rise significantly, causing a decline in the stock market. This fear is mainly based on inflationary expectations, rather than on actual inflation data.

No fear of inflation in the Eurozone

Outside the United States, however, there are few signs of inflationary pressures. In particular, the situation is very different in the Eurozone, where inflation is likely to converge very gradually towards the 2% target set by the ECB. The data published in January, with the annual consumer price index that fell to 1,3% (and the core index at 1%) confirmed a weak inflationary trend. The upward movement of the currency in the last 12 months is further easing tensions.

 Looking for a favorable entry point

For the moment, there is no reason to question our baseline scenario. In fact, we expect the Goldilocks context to prevail throughout 2018, thanks in part to continued support from fundamentals. Stocks got even more attractive after the recent correction. US equity markets are currently trading at a multiple of 17x earnings for 2018, while just a week ago the forward P / E was still above 20x. Finally, strong earnings growth should continue to support equity market performance. In this fundamentally solid market environment, and while we may see a second wave of systemic selling, we look forward to stabilizing market dynamics and a good time to further increase our equity exposure.

 

Candriam: US stock; sudden technical sell-off, but the fundamentals hold. Three possible scenarios for the US for the 2018-2019