Equities: Oh what a year!

If a week is a long time in politics, then a year is an age in investment markets - and 2019 has turned out to be quite a year indeed. As we gazed into our crystal ball last year, we were optimistic on the prospects for markets over the course of the year, particularly given the steep sell-off seen in the final quarter of 2018.

But even wearing our most optimistic hat, we would not have forecast the returns from equity markets that euro-based investors have seen over the last 12 months. This is particularly true in light of the age of this current bull market but also given the deterioration we witnessed in both economic and corporate fundamentals over the period.

How did we get here?

Therefore given the backdrop, it seems logical to ask what was driving the returns in equity markets last year. The two charts below deconstruct the annual returns for the US and European markets for the last eight years. As you can see, the largest contributor to returns in both regions in 2019 was the expansion in valuation multiples - indeed, on a global basis, forward price/earnings (P/E) ratios expanded from 12.9x to 16.4 x over the period.

• Figure 1: breakdown of returns for US & European markets

Where to now?

As we look to 2020 expecting positive returns to be generated by further valuation expansion looks optimistic to us - therefore the burden will fall on corporate fundamentals, and in particular, corporate profit growth. To this end, analysts are currently forecasting global profits to expand by 9.6% in 2020, and while this may prove to be on the high side in our opinion given the continued uncertainty around US/China trade relations, we do expect positive growth in profits over the year.

From a sector perspective the strategy in 2020 will be influenced by the maturity of the bull market and the economic cycle. To this end we should begin to see a move from the spectrum extremes of deep cyclicals and expensive defensives more towards the middle ground. Sectors that offer lower levels of growth but more reasonable valuations should outperform and we are likely to see greater performance disparity between stocks within sectors as traditional stock correlations decline.

Returns may be harder to come by in 2020, but there should still be 'some life left in the old bull' (market) yet.