Global equity markets continued rebounding in Q3, rising 6.3% and notching several new all-time highs along the way.[i] But as October dawned, volatility struck global markets anew. UK markets entered correction territory (a correction is a sharp, sentiment-fuelled drop of at least -10%), and global markets came close. Yet whilst the big swings can test many investors’ nerves—and volatility may persist in the near term—we think this appears to be sentiment-driven—likely temporary. In our view, investors’ focus will likely soon shift from political uncertainty and rehashed fears to positive global fundamentals.
With Q4 underway, we enter a particularly bullish period Ken Fisher calls the 87% Miracle—three quarters surrounding US legislative (or “midterm”) elections where US equity returns have historically been quite consistently positive. Those elections occurred on 6 November. This isn’t about magnitude—it is about direction. Since 1926, US equities have risen in 87% of midterm year Q4s and each of the following two quarters individually—far more frequent gains than the typical quarter.[ii] Better still: Even in the eight instances when at least one quarter was negative, cumulative returns for these nine months were still positive in six. Only twice have US shares fallen cumulatively between the midterm year Q4’s start and the following Q2’s end: Q4 1930 – Q2 1931, during the Great Depression, and Q4 1938 – Q2 1939, as Hitler’s territorial ambitions grew. All the other nine-month periods were up, an overall 91.3% frequency of positive returns.[iii] So in our view, the three individual 87% Miracle quarters, seen through a longer-term lens, are really the nine-month 91.3% Miracle.
Whilst October was volatile, we don’t think this inherently precludes the 91.3% Miracle. It actually isn’t even unusual. Since 1926, eight midterm-year Octobers saw declines.[iv] In only two did this lead to a negative Q4.[v] And only one negative October ushered in a nine-month midterm stretch where stocks fell.[vi] That said, volatility and corrections are always possible, and we think expecting them is generally a healthy mindset. Such moves, in our view, aren’t predictable—because they are driven by sentiment and not fundamentals. Hence, for investors who want or need equity-like returns for some or all of their portfolio, we don’t see such short-term swings as a reason to avoid owning equities. We think this bull market will reassert itself before long, with positive political fundamentals contributing to rising equity markets.
We think midterm elections drive positivity for a simple, underappreciated reason: They tend to increase political gridlock, preventing radical legislation. Whether Democratic or Republican, the American president’s party tends to lose relative power in midterms, likely stymying controversial legislation and easing political risk. We think the absence of this negative is positive. Yet we have observed many investors failing to see this, perhaps because voters are often frustrated by the lack of action justifying their vote. We think this is why we haven’t seen anyone else in financial media mention the 87% Miracle. And why it seemingly hasn’t lost its apparent power to move markets—it likely isn’t “priced in” or reflected in investors’ broad expectations.
Whilst the 87% Miracle centers on US politics, we think it is bullish for the world. US shares have been highly correlated with markets from the rest of the developed world during this bull market—one never zigs for long whilst the other zags.[vii] Europe moves nearly in lockstep with America, and the UK is highly correlated as well.[viii] Though correlations measure only direction, this shows good times for US equities have historically been good times for the developed world overall, in general, extending the 87% Miracle’s effect globally.
European returns haven’t been stellar in 2018 to date, as Italian budget fireworks, Brexit bickering, ascendant populists and other forces have dampened sentiment, along with fears of the European Central Bank (ECB) further reducing its asset purchase programme, known as “quantitative easing” (QE). But we expect the tide to turn before long, making now a good time to emphasise these nations, in our view. The 87% Miracle’s global bullishness should help Europe but, in addition, we expect false fears and political uncertainty to fade, allowing investors to see what we think are better-than-appreciated fundamentals.
Whilst many fear Italy’s populist coalition government will squabble with Brussels—potentially even attempting to leave the euro—we think reality is likely more benign. Media coverage and politicians’ public comments show Italy’s populist government is internally divided on many key issues and, crucially, neither party officially advocates a euro exit. Further, Italian debt is quite manageable in historical terms, suggesting the budget debate shouldn’t much matter to Italy’s solvency.[ix]
As for the ECB slowing its asset purchases, we think this is bullish. When the ECB purchased long-term assets, it reduced long-term interest rates. Conventional wisdom argues this stimulated borrowing, growth and equity markets. In our view, it achieved the opposite—slowing lending and growth. There is a simple, time-tested reason for this, in our view: QE lowered long-term rates whilst the central bank pegged short-term rates just below zero, flattening the yield curve—the difference between short- and long-term interest rates. Because banks borrow short term to fund long-term loans, we think a flatter yield curve generally makes lending less profitable—and, hence, it likely reduces banks’ willingness to take risks and make loans. There is already evidence reducing and eventually ending QE isn’t bad: Lending and GDP growth picked up in America and Britain after the US Federal Reserve and Bank of England reduced and ended their asset purchase programmes in 2014 and late 2012, respectively.[x] We saw the same last year in Europe, after the ECB began reducing the amount of its monthly asset purchases.
From ending QE to Brexit—potentially including a “no-deal” Brexit in which the UK leaves the EU next March without a new trade agreement—we anticipate widespread relief as these things many investors fear finally happen and don’t bring disaster. In our view, the more they get on with it, the more investors can get over it, freeing markets from the fog. As they do, we expect investors to see continued GDP growth, steep yield curves and positive monthly economic data.
Overall, we think there is much for investors to like these days. Swift earnings growth continues, powered by robust revenues—a sign recent US tax cuts alone aren’t responsible for burgeoning corporate profits.[xi] Positively, the UK and most developed nations are politically gridlocked. The “Goldilocks” economy persists, with moderate growth and mild inflation across the globe—not too hot, not too cold, but just right, like Goldilocks’ preferred porridge in the classic folktale. Troubles in Argentina and Turkey steal headlines, but Emerging Markets overall are growing swiftly, boosting demand for goods and services from the developed world.[xii] The US and Chinese economies are seemingly shrugging off tariffs, with most indicators showing growth.[xiii] Several new trade agreements are in progress, defying protectionism fears.
In short, we expect positive returns to continue through 2019’s first half at least. The third year of a US president’s term is historically the most consistently positive, with the highest average return.[xiv] The 91.3% Miracle is the gateway to this, in our view.
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Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. The value of your investments may fluctuate. International currency fluctuations may result in a higher or lower investment return. Past performance is never a guarantee of future returns.
This document constitutes the general views of Fisher Investments UK and Fisher Investments, and should not be regarded as personalised investment or tax advice or as a representation of their performance or that of their clients. No assurances are made that they will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts may be, as accurate as any contained herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited Headquarters: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom. Fisher Investments Europe Limited’s parent company, Fisher Asset Management, LLC, trading under the name Fisher Investments, is established in the USA and regulated by the US Securities and Exchange Commission. Investment management services are provided by Fisher Investments.
1 Source: FactSet, as of 3/1/2018. MSCI World Index return with net dividends, 31/12/2016 – 31/12/2017.
2 Source: FactSet, as of 3/1/2018. Based on MSCI World Index calendar-year returns with net dividends.
3 Source: Global Financial Data, Inc. and FactSet, as of 28/12/2017. Annualised price returns in USD for bull markets from 1926 to 2007. The current is omitted as it is incomplete. GFD World Index used for bull markets from 1926 – 1970; MSCI World Index from 1970 – 2007. The MSCI World Index’s 2017 price return in USD was 20.1%. Currency fluctuations between the dollar and pound may result in higher or lower investment returns.
4 Source: FactSet, as of 3/1/2018. MSCI World Index return with net dividends in EUR, 31/12/2016 – 31/12/2017.
Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.