THE STORM some investors found themselves in during the final three months of 2018 has seemingly passed, based on the rapid recovery across global equity and credit markets in the subsequent first three months of 2019.
The fourth quarter of 2018 was one of the worst on record but risky asset classes went well in quarter one and we saw a 13.6 per cent increase in the S&P 500 Index. during that period
Economic activity often ebbs and flows like this in the late stage of the business cycle, creating a fertile breeding ground for investor pessimism.
Nevertheless, it is worth considering whether investors were too pessimistic in in the final quarter of last year - and if they are being too optimistic now.
It is true that geopolitical risks, such as the US–China trade conflict and the possibility of a hard Brexit, justify some investor pessimism.
However, the fact that US–China trade negotiations are ongoing removes one obstacle for investments going forward and, while a hard Brexit still cannot be ruled out, other scenarios have a much higher probability following the latest extension to the Article 50 process.
Hence, we view any share-price weakness related to these geopolitical issues as an attractive entry point for long-term investors who focus on fundamental factors. The inversion of the US yield curve is not necessarily a sign of an imminent contraction of GDP.
The showdown between the US Federal Reserve Bank and financial markets appears to have been resolved, with risky assets seemingly winning the day.
After financial markets were sent into a tailspin in the final quarter of 2018 due to a combination of a slowdown in the cyclical backdrop and tighter monetary policy, the Fed shifted its policy stance and in January pledged to be patient before hiking interest rates any further.
Thanks to the Fed’s balance sheet reduction ending in the autumn and interest-rate hikes being paused for the moment, conditions appear set for the US yield curve to steepen in the coming months.
Meanwhile, lower mortgage rates should stimulate housing and other interest rate-sensitive sectors of the US economy.
The Fed’s monetary policy pivot has proved critical to ensuring asset-price stability.
This is key because the US economy has become more sensitive to wealth effects through changes in asset prices rather than changes in credit demand, triggered by changes in the cost of capital.
At the same time, China is slowly shifting from a position of deleveraging to stimulating its economy.
This matters because the growth outlook for emerging markets, Europe and Japan is at the mercy of the revitalisation of Chinese growth.
Leading Chinese indicators improved in March, adding to tentative signs of an economic stabilisation, which should be taken as positive news for the global economy.
Nevertheless, we are likely to see China’s stimulus measures continue and growth prospects improve further once the ongoing trade war ends.
We have a brighter view than most analysts on the economic situation in the United States, China and Europe, although the Fed and the European Central Bank have probably become too dovish.
Closer analysis of capital flows appears to support the continued ascent of global equity markets.
In the first quarter of this year, equity funds recorded outflows of $80 billion, with US and European stocks being the main losers.
Seemingly, investors used the recent rally to trim their equity positions, which is hardly a sign of exuberant optimism and, from a technical perspective, we feel this enhances the equity markets’ prospects.
Overall, as has been the case for the past decade, time in the market and staying the course continues to be the right decision as opposed to timing the market and exposing oneself to whipsawing of markets driven by the weight of mechanical money.
Calum Brewster is head of UK regions at Julius Baer.
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