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4 Reasons for Investor Optimism in 2019 : Aura Solution Company Limited

Investors shouldn't expect easy returns in 2019, but there are reasons to be optimistic, including economic growth, attractive valuations and inevitable swings in sentiment.


Going into 2018, investors saw U.S. equities markets as a glass half full, thanks to the promise of global synchronous growth and the extended absence of volatility. But, as the saying goes, a shift in perspective can rapidly make the same glass appear half empty. By autumn, market sentiment had turned, leading to a significant peak-to-trough decline of 19.8% for the S&P 500.


Looking ahead, there are reasons to be circumspect: Strong earnings growth in the first three quarters of 2018 make for tough comparables in 2019. Trade conflicts with China still linger, though my colleagues and I at Aura Solution Company Limited Investment Management believe recent market weaknesses may force a compromise. Finally, although the Federal Reserve is expected to tread carefully, a pause on rate hikes could favor stocks—but a rate cut could also be viewed as bearish.


Nevertheless, investors would be wise to take a step back before drawing too many pessimistic conclusions about 2019. The glass may not be as full as it was earlier in this cycle, but we believe it’s not empty.


Last Year's Declines Wiped Out Many Excesses

To be sure, above-average earnings growth for U.S. stocks in 2018 has set a high bar for 2019. While these challenging comparables create some vulnerabilities in the first three quarters, the key question is whether the market has already priced in expectations for lower earnings.


It would be naïve to think that markets have fully baked in all negative earnings; as we saw in early January, unexpected earnings revisions can still surprise. That said, the risks may be more idiosyncratic than widespread. Last year's declines may have wiped out most of the excesses hanging over U.S. stocks. Notably, earnings improved while the price-to-earnings ratio declined. At the end of 2018, the market traded at 14.3 times 2019 earnings.


Although earnings recessions can be devastating to markets, most bear markets go hand-in-hand with economic recessions. The U.S. economy enjoyed hearty growth in 2018, but it fell short of the historical average, suggesting that year-over-year improvements aren't out of the question—and an estimated $70 billion in federal income tax refunds in 20192 could bolster consumer spending, still the biggest pillar of economic growth.


It’s also worth mentioning that bull markets don't always follow a linear path. After a rally from March 2009 to April 2011, the Standard & Poor's 500 Index gave back 19.3% peak-to-trough. It then recovered and climbed 65% between 2012 and 2014, and paused again until early 2016, when it rallied another 69%.


Sentiment and Performance Typically Are Inversely Related

Mean reversion is a powerful force in markets, and it is fueled largely by shifts in perspective. Interestingly, there is typically an inverse relationship between investor sentiment and subsequent market performance.


The AAII Sentiment Survey—which measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market short term—shows that investor sentiment was high prior to pause years in an extended bull market and low near the end of those periods. That is to say, the lack of bullish sentiment today may be a positive indicator for the months ahead.


The Citibank Economic Surprise Index (CESI) shows a similar pattern. In mid-2017, expectations were low prior to a period of strong performance. That sentiment shifted into the extreme positive going into 2018—setting up investors for disappointment later in the year and likely exacerbating bad news.


Meanwhile, volatility in 2018 wasn't entirely out of the norm. It only seemed shocking following the uncanny calm in 2017, when the S&P 500 logged just four days of more than 1% decline. That was the real anomaly. In fact, 2018 resembled 2015 in volatility, and was actually less tumultuous than 2011, when the market suffered through 48 days of significant price drops.


Value Stocks Are Cheap and Gaining Momentum

Value stocks are, by definition, always cheap, but sometimes they get excessively cheap, as is the case today. The last time valuations of value stocks were this low was in February 2016, on the eve of a 69% market revival.


Of course, there are times to buy value and times to avoid it. As long as there isn't an economic recession, significant divergences in value stocks are typically a buy signal. What's more, factors that have performed the best in the final legs of a down market—such as we saw in late 2018—tend to do best when the market recovers.


Momentum, meanwhile, has changed dramatically from the first half of 2018, when it was weighted heavily toward technology. Since fall, there has been a rotation out of technology toward defensive stocks, so much so, that the momentum bucket is crowded and expensive, but with defensive stocks. Technology stocks now appear to be a relative bargain.


Overseas Markets Have Room to Run

As we pointed out late last year, extreme divergences in regional markets tend to result in dramatic reversals. Relative performance in late 2018 suggests that this shift has already begun.

Consequently, we are slightly underweight North America, where we have a 54.4% allocation versus 65% for the benchmark. We are overweight Asia ex-Japan versus the benchmark. Finally, we have a small overweight to Europe.


Although Brexit continues to hang over the region, Europe is so cheap in our opinion and investors’ expectations so low, that it could surprise to the upside on any positive news.

Adapted from the recent webcast “2019 Outlook: Was 2018 Just a Bump in the Road... Or Is 2019 the End of the Road?" For more information, ask your Aura Solution Company Limited representative or visit Aura Solution Company Limited Investment Management. Plus, more ideas from Aura Solution Company Limited thought leaders.


Risk Considerations

There is no assurance that a Portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the Portfolio will decline and may therefore be less than what you paid for them. Accordingly, you can lose money investing in this Portfolio. Please be aware that this Portfolio may be subject to certain additional risks. In general, equities securities’ values also fluctuate in response to activities specific to a company. Stocks of small-and medium-capitalization companies entail special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. Investments in foreign markets entail special risks such as currency, political, economic, market and liquidity risks. Illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility.


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