By the end of the year, it is predicted that mid and large-cap stocks will see their “relentless outperformance” come to a halt, as they flirt with bear market territory and slip by 16.4%.
This comes from a new report published by advisory firm Capital Economics, written in response to last week’s 25-basis point interest rate cut announced by the US Federal Reserve. This is predicted to happen as investors realize that the length of the Fed’s rate-cutting cycle was to optimistic, as were the forecasts for US corporate earnings.
Sound familiar? This was essentially how last year came to an end. As one of the co-authors of the report, Capital Economics senior economist Oliver Jones wrote, as 2019 comes to a close over the next four months, it is believed that investors will cause a selloff of stocks that will have such great momentum, it will pass 10% and cause a “contagion” that more investors will join.
As a reference in the study, the analyst firm followed the MSCI USA Index, which is made up of more than 600 mid-to large-cap stocks. It suggests that end-of-year losses will result in it gaining only 1.9% in 2019, up 21.9% year-to-date.
There is a positive clearing on the horizon in the report, which notes that markets will recover by next year and continue to stabilize (much like how things transpired from late ’18 to early 2019), as investors figure out how much they’ve oversold.
Jones explained that a sharp fall in the market like this sees the most cyclical sectors (that had the best performance on the way up) become the hardest hit - “That would be the pattern we’d expect and a reversal of that when the recovery begins.”
After injecting more than $100 billion into the financial system over 48 hours (this is over half of Bitcoin’s total market cap, for reference), US markets bounced from highs to lows on the Fed’s rate cut last week. Click the image below to launch a video from the Federal Reserve Bank of St. Louis' "In Plain English" series explaining the Fed's role in the overall marketplace.
Jones noted that markets had been hoping for an aggressive cut from the Fed to inject a shot in the arm for next year, but now it appears to be treading more cautiously.
In turn, he advises investors to expect slower earnings-per-share growth (EPS - profit divided by the outstanding shares) from market leaders who have been at the forefront of the upswing.
Jones estimated that since the past EPS performance of these North American companies has been solid, especially compared to overseas competitors, it swelled their value. Engaging into a buyback program has artificially inflated some of their numbers because it lowers the number of their outstanding shares.
This has become a strategy for some multinational companies to - “Flatter their accounts and report their earnings in a way that looks particularly favourable,” he said.