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The stock market slide won't turn around in 2019 until rate hike expectations for the Federal Reserve stop rising and earnings estimates for companies by analysts stop falling, according to Bank of America Merrill Lynch Global Research.
"The 'Baby Bear' market on Wall St that began in 2018'Q1 not yet over," Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research, said in a note to clients. "We expect to turn tactically bullish once peak rate and trough EPS expectations signal 'The Big Low.'"
Markets around the world have been increasingly volatile this year. The entered a correction in October, falling 10 percent from an all-time high hit on Sept. 21. In Asia, the Shanghai Composite is trading in a bear market, down 26 percent from its 52-week high.
Two of the main culprits for the wild ride on Wall Street have been worries about tighter monetary policy from the U.S. central bank and fears that corporate profits growth will slow down.
The Fed has raised rates three times in 2018 and is expected to hike once more later this month. The central bank also expects to raise rates twice in 2019. Rate-hike fears were somewhat quelled last week after Fed Chairman Jerome Powell said the central bank's benchmark rate was "just below" neutral, hinting at fewer rate hikes down the road. But BofAML expects the Fed to hike four times in 2019, Hartnett said.
Corporate earnings have grown sharply this year. During the first three quarters of 2018, S&P 500 earnings jumped by at least 25 percent on a year-over-year basis. Fourth-quarter earnings are also expected to be strong. However, the growth rate is likely to slow down as a boost from lower corporate taxes in the U.S. fades. Globally, PMIs and a weaker export cycle in Asia point to earnings growing by less than 5 percent in 2019 from more than 15 percent in 2018, according to Hartnett.
"We believe asset prices will find their low once rate expectations peak and EPS expectations trough," Hartnett said. "A rally in emerging-market currencies, the KOSPI (Korea Composite Stock Price Index), copper, [and] global industrial stocks would confirm China/global EPS expectations at a trough; a rally in REITs, homebuilders & semiconductor stocks would confirm Fed rate expectations peaking."
Hartnett says investors should buy next year the iPath S&P 500 VIX Short-Term Futures ETN (VXX), which rises along with the Cboe Volatility Index (VIX) futures, as a way to benefit from the continuing volatility. The instrument has risen 31.7 percent in value this year, handily outperforming the S&P 500.
He also advises investors buy into Brazilian, Russian, Indian and Chinese stocks while shorting the popular FAANG trade, which is made up of Facebook, Amazon, Apple, Netflix and Google-parent Alphabet. The strategist also recommends buying the SPDR S&P Homebuilders ETF (XHB).