It may be early in 2019 but many share market investors are still recovering from the pasting they got near the end of 2018.
While the Australian market held up fairly well, it was still a really bruising experience as hard won gains that had built up over months and even years evaporated like so much morning fog.
It was even worse in the US with both the tech heavy Nasdaq and the broader S&P 500 falling into bear markets, which means a fall of more than 20% from the peak.
Is correction a warning?
The obvious question after being hit by that train is does this represent a great buying opportunity or is it a warning that markets are just going to get worse from here on.
Unfortunately, the answer to that question will only become apparent over time, with the luxurious benefit of hindsight.
There are some positive signs with a bounce in most markets to start the New Year and also a surprising recovery in some commodity prices since the searing falls in the second half of last year.
Iron ore – which is one of Australia’s major exports – has risen an impressive 20% since bottoming out in November while copper, nickel and oil are all up by lesser percentages.
That could turn out to be a dead cat bounce or the start of a recovery but at least one indicator is predicting that this could be an opportunity to buy the dip rather than a signal to hit the exits.
Citigroup’s Bear Market Checklist suggests that investors should be “buying the dip”, because global stock markets are more pessimistic about 2019 corporate earnings than analysts are.
According to Citigroup strategists, fears of a recession are overdone and 2019 should only see a slowdown in earnings-per-share growth.
Positive return from global equities
Citigroup analysts including Robert Buckland and Jonathan Stubbs forecast returns in global equities of 14% this year, with their “bear-market checklist” showing just 3.5 red flags out of a possible 18.
“Equity valuations aren’t stretched, fund inflows have been miserly and corporate behaviour subdued,” said Mr Buckland.
He said that “a flat yield curve and rising credit spreads are worrying, but traditional signs of bull market euphoria remain notably absent”.
Citigroup predicts that global company earnings per share (EPS) will grow by an average 4% in 2019, below consensus predictions of 7% but well above the 4% contraction being priced into markets.
“Of course 2019 will be a tougher year for EPS than 2017 or 2018, but not that much tougher,” said Mr Buckland.
Citigroup’s analysis shows that in 21 years of downward revisions to profit estimates over the last 30 years, stocks went up in 14 of them.
Bear market checklist not slashing sell
“Our Bear Market Checklist helps us compare current global market variables to those before previous major bear markets,” the Citigroup research said.
“Right now, only 3.5/18 factors are flashing sell compared to 17.5/18 in 2000 and 13/18 in 2007.”
It is important to note that the Citigroup research is not a market timing model but it does indicate when market dips are justified by fundamentals and when they may not be – helping to sort out the dead cat bounces from the buying opportunities.
While the vast majority of variables point to the coast being clear for investors to pile in, Citigroup does warn to keep a weather eye out for the flattening US yield curve and rising credit spreads.
Helping to offset the recession warning signal being generated by the yield curve, Citigroup said that “equity valuations do not look stretched and the equity risk premium is still quite high”.
It also said that “corporate activity is not excessive and fund inflows have never picked up strongly”.
Not the end of a bull market
From a historic perspective, the bank says red flags have normally “accumulated gradually before rising exponentially” in the last year of the bull market.
That is not the case at the moment, although Citigroup warned that it will become more worried when seven or eight of the factors are flagging caution.
Europe could be a weak spot
In Europe, the strategists downgraded UK stocks to neutral as Brexit uncertainty weighs on confidence, though they don’t expect a “no-deal” outcome and note a lot of the bad news is already discounted.
Mr Stubbs said it is possible that EPS in Europe could contract this year, due to the heavy exposure to a slowdown in global trade.
The European head strategist sees EPS downgrades remaining a drag, but said he expects a “re-rating later in the year as global recession fears abate”.
Emerging markets the place to be
Forecasting the US dollar to weaken this year, the strategists upgraded emerging-market equities to overweight, making them their preferred value trade.
They also kept an overweight rating on US stocks, with the slowdown in earnings per share already priced-in, while staying underweight in Australia and Japan.
Citigroup recommended a balanced approach to sector exposure, with a mix of cyclical and defensive equities.
The bank now has an overweight rating on communication services and health care in the defensive space, and picked industrials as the preferred cyclical sector.
Energy, financials, materials and information technology are rated neutral, while consumer staples, utilities and consumer discretionary remain underweight.