20 December 2018
2018 - Annus horribilis
In January, the consensus pointed to a market buoyed by one of the highest earnings growth of the cycle, tax cuts that were expected to unleash more investment, consumer and business sentiment hitting all-time highs, and one of the tightest job markets in 50 years. Market sentiment was so positive that one would have been hard-pressed to find a bearish strategist.
More than 90 per cent of asset classes are in negative territory for the year - a once in a century event. It has been a disastrous year for the average hedge fund, which has been unable to provide any hedged returns, with the S&P 500 in top quartile against the average fund manager.
Sentiment is washed out
The contrarian in me is piqued. Sentiment indicators everywhere are flashing red as investors have turned bearish. Although fundamentals are mostly benign and earnings are still expected to grow next year, price-to-earnings ratios have been slashed. The market is finally souring on technology and the so-called FAAMG stocks of Facebook, Amazon, Apple, Microsoft and Google.
Source: Refinitiv, Fidelity International, December 2018.
Last year, I highlighted that the concentration of mega-cap technology stocks at the top of the S&P 500 is an unprecedented event and would eventually end in tears. I was hopelessly wrong until September, but the risk-off end to the year is related to the tightening liquidity conditions and the market finally starting to evaluate the earnings’ sustainability of these global behemoths. I don’t expect these companies to disappear but a majority of them could chart the paths of Wal-Mart, Cisco, GE, IBM and Intel in the early 2000s - stocks that did incredibly well for a generation until they became too big for their own good and never quite regained their leadership of the market.
With old leaders like FAAMG stocks starting to falter, the market is looking for new leadership. Luckily there are enough stories in other parts of the market to keep us interested.
Let me start with software. We are in the early stages of rewiring the overall technology infrastructure of the world to mobile first and cloud, and in this paradigm new Software-As-A-Service (SAAS) leaders like Salesforce will dominate the landscape. If we look at the performance of the S&P 500 Software Index over the past few months, it has handily beaten the NYSE FANG+ Index and we have years to go before this is over. According to our estimates, SAAS will take over from on-premise software by 2022 and will continue to outpace overall technology spending.
Source: Refinitiv, Fidelity International, December 2018.
The healthcare industry is in the early stages of fundamental overhaul as Fee-For-Service gives way to Fee-For-Value and healthcare spending as a percentage of GDP starts to taper and then decline. Healthcare in US will move out of hospitals into homes, medical shops and standalone surgery centres as the system reduces the cost of care.
Over the next decade, we will see fully-automated electric cars becoming more ubiquitous, 5G allowing fast broadband on the move, and medicine being tailored for the individual using genetic data. The possibilities are endless.
The bull market is dead, long live the bull market
I remain convinced that we are in a secular bull market in the US that started in 2013 and will last for at least a few more years. Secular bull markets have cyclical corrections but these need to be bought rather than sold. I don’t know how 2019 will start or end, but the sentiment is depressed and I firmly believe there is value to be found in this market.
The value of investments and the income from them can go down as well as up so you may get back less than you invest. Past performance is not a reliable indicator of future results.
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