The US equity downdraft in December is not due primarily
to a rise in market perceptions of tail risks or to a sharp dialing down of baseline growth expectations.
We think the reason is simpler: retail outflows have picked up sharply in December, unlike in the October
sell-off. We believe that fundamentals should re-assert themselves over the medium term; at current
levels, US equities are reasonably attractive for investors with a 6- to 12- month horizon.
US equities have taken another leg down in December, sparking a global risk-off. Usually, one of two
reasons drives any such move:
Investors have re-priced downwards their baseline for economic
and earnings growth,
Or markets are now pricing in a greater possibility of a tail risk
materializing and are, hence, demanding more risk premia.
We do not subscribe to the view
that the December risk-off is because investors have dialed up their forecast for a US recession. A 2019
recession is not a realistic probability in either recent data or our forecasts. Despite the rate rally,
US bond markets are not seriously pricing in a recession, either. Rather, they simply seem to be telling
us that they believe the Fed hiking cycle is close to being finished.
It is also hard to
ascribe the sell-off to markets’ suddenly assigning much higher probabilities to tail risks
materializing. The news flow for the past several weeks has been almost uniformly positive, whether it is
the Fed’s dovish tone, encouraging news on US-China trade talks or the Italy budget stand-off. The
volatility markets also support our view that the recent move is not due to panic among institutional
Instead, we believe that a sharp rise in retail outflows has been the main driver
of the most recent move, with selling indiscriminate across sectors and styles. Record mutual fund
outflows in recent weeks and extremes in retail sentiment on equities in October (which were largely
absent during the initial selloff) support this narrative.
Given our belief that this risk-off
is not driven by a change in investors’ fundamental outlook, equities look reasonably attractive, even if
P/E multiples do not recover from the recent compression. It is hard to step in the middle of the
relentless selling and bearish sentiment of recent weeks, and also difficult to estimate when the
But we believe that the fundamentals should re-assert themselves sooner than
later, which implies a move higher for US equities for investors with a 6- to 12- month horizon.
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