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Abu Dhabi, UAETuesday 11 December 2018

Five global indicators that tell us how the stock markets will fare this year

While no one has a crystal ball, there are several methods to use to predict how the world economy is faring

Illustration by Alex Belman
Illustration by Alex Belman

Investors have suffered a torrid start to 2018, as volatility returned to global stock markets with a vengeance.

February saw a market correction as fears over rising inflation and interest rates met long-standing worries about pricey stock valuations.

Just as markets were beginning to settle down, President Donald Trump proposed tariffs on aluminium and steel imports - threatening a global trade war.

So, the question everybody wants to know is this: what happens next?

No investor has a crystal ball but Russ Mould, investment director at online trading platform AJ Bell, says there are several methods you can use to predict where the world economy may be heading. “Interest rates, wages and inflation all have an impact but five lesser-known indicators can show you whether markets are likely bounce back or have become dangerously bubbly to the point of bursting.”

Given the current gloom, it is good to know that none of these five signals are flashing danger right now. “In fact, many continue to flash ‘green' for go,” Mr Mould adds. The five stock market indicators are:

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1. The transportation indices

If the global economy is strong, output is healthy and exports are flowing, this will show up in the transport figures.

If transport indices are falling this is bad news for industrials, Mr Moulds says. “If nothing is being shipped, nothing is being sold. It is therefore reassuring to see both the FTSE All-Share Industrial Transportation and America’s Dow Jones Transports indices powering higher.”

One year ago, the FTSE All-Share Industrial Transportation Index stood at 4634. On Friday it closed at 5761, around 24 per cent higher.

The Dow Jones Transportation Average has also been motoring over the past 12 months, rising almost 18 per cent from 9123 points to 10,739.

Importantly, they have continued to make gains amid the current uncertainty, rising 4.7 per cent and 4.3 per cent respectively over the last month. Stock markets may be volatile, but the global economy is still on track.

In January the International Monetary Fund upgraded its World Economic Outlook Update to predict 3.9 per cent GDP growth for 2018 and 2019, up from 3.7 per cent last year, amid a synchronised global growth upsurge.

Ben Kumar, investment manager at mutual fund provider 7IM, says concerns about this year’s volatility have been overdone. “Bull markets do not simply run out of steam," he says. "They need a catalyst, yet global growth looks set to continue.”

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2. Dr Copper

If you want a diagnosis of the global economy’s state of health then book an appointment with Dr Copper.

Copper is perhaps the most important industrial metal, used in electrical generators, motors and wiring, phones, TVs and radio sets, as well as car radiators, air conditioners, heating systems, water pipes and locks.

This makes it an excellent global economic barometer, because a rising copper price points to healthy construction and manufacturing activity, and strong business and consumer demand.

Two years ago, in January and February 2016, stock markets crashed on fears that the Chinese boom was coming to an end. At that point, the copper price hit a six-year low but it has soared since then.

Over the past 12 months it has rise from $2.7 per pound to today’s price of $3.14, although it dipped slightly from $3.2 a month ago.

“Keep an eye on Dr Copper," says Mr Mould. "If its price continues to increase, this would reaffirm investors’ faith that the reflation trade is the right one.”

The global recovery looks copper-bottomed for now.

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3. Smaller companies

The performance of smaller companies can also point to the temperature of the global economy, Mr Mould says: “Small caps tend to outperform when investors are bullish and fall faster than the broader market when they are bearish. This greater volatility makes an excellent indicator of investor appetite for risk.”

He names two smaller company indices to follow, the FTSE SmallCap Index in London and the Russell 2000 Index in New York, whose charts can be easily Googled.

Both continue to make solid progress, even if the mega-cap FTSE 100 and Dow Jones Industrials have been hogging the headlines.

“Bulls will want to see these benchmarks keep ticking higher and their gains so far offer a positive sign,” Mr Mould says.

The FTSE Small Cap has risen 7.5 per cent from 5370 to 5776 over the past 12 months, and although like pretty much every other index it dipped during February's volatility, it is now on the mend.

The Russell 2000 is up an even more impressive 16.5 per cent in the past year and has also recovered well in recent days.

A smaller company snapback suggests that investors have not given up on stocks and shares yet. Again, another green light.

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4. Stock market volatility

Last year was typified by incredibly low volatility, but the opposite has been true this year, so which is preferable?

The CBOE Volatility Index, known by its ticker symbol VIX, measures 30-day prospective volatility based on put and call options taken out on the S&P 500 index.

The VIX was astonishingly flat last year, trading either side of the 10 mark before spiking to 29 on February 8, as markets started selling off. Calm is now returning, with the VIX closing at 14.64 last Friday.

Mr Mould says volatility can be the stock market trader’s friend, offering opportunities to buy stocks low and sell them high, but it is an unreliable friend. “History shows that stock indices do best when they make a series of modest gains and tend to fare less well when trading is choppy and there are big swings up and down.”

He would like to see stock markets post a steady, incremental recovery rather than crashing down or shooting up. “This would assure investors that we are not in a frenzied bubble that is primed to burst,” he says.

Sam Instone, chief executive of AES International, says low volatility does not always indicate economic strength. “Global markets have not been volatile lately compared with historical norms but that reflects central bank monetary policy, rather than the health of the global economy.”

The assumption that global central bankers would step in to avert any market crash has underpinned investor confidence and share prices since the financial crisis. As the US Federal Reserve and others gradually start to increase interest rates, this artificial support is drawing to a close.

Mr Instone says a return to volatility is nothing to fear: “At its most fundamental, market volatility is created by market participants discovering the fair price for an asset or security. This is constantly happening and is entirely healthy.”

Volatility may have subsided for now, but keep an eye on where VIX goes next.

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5. Dividends

Dividends are the regular cash payments companies give shareholders as a reward for holding their stock.

Businesses that generate plenty of cash tend to pay the highest dividends, which makes the payout a mark of business success and confidence.

Mr Mould says payments are not guaranteed and can be reduced or scrapped in tough times. “Company management is reluctant to cut payouts as this damages investor confidence and hits the share price hard.”

Last year set new records for dividend payouts with global investors receiving a record $1.25 trillion, a headline rise of 7.7 per cent on 2016, according to the Janus Henderson Global Dividend Index.

This was the fastest rate of growth since 2014 and Ben Lofthouse, director of global equity income at Janus Henderson, expects strong earnings growth to continue in 2018 with the US, EU and China expanding at the same time. “Companies are seeing rising profits and healthy cash flows, and that’s enabling them to fund generous dividends,” he says.

Last year’s record payout was almost three-quarters higher than in 2009, and headline rates should rise another 7.7 per cent to $1.35tn. “The next few months are set fair, and we expect global dividends to break new records in 2018,” Mr Lofthouse adds.

Mr Instone urges caution when looking at dividends, particularly yields, which are calculated by dividing the dividend by the company's share price. “If the share price falls, the yield goes up. This is not a reflection of how a company is doing financially,” he warns.

Mr Instone says it is far better to look at for a consistent track record of dividend growth stretching back over five or even 10 years. “If the dividend has increased consistently this suggests the company is managed well, and has a strong focus on investor returns. A volatile dividend may indicate a company board that cannot manage cash flow.”