Equity markets spent January in the shadow of the main central banks, particularly the US Federal Reserve.
Under the reign of central banks
After a poor start on 2 and 3 January, Fed Chair Jerome Powell reassured investors by flagging a more flexible approach to monetary policy in an interview on 4 January. Further reassurance came from the People’s Bank of China (PBoC) which reduced banks’ reserve requirement ratios. Stocks began trending up and clawing back their steep December losses.
After dropping by 7.2% in December, the MSCI AC World index gained 7.8% (in US dollar terms) in January, hitting a high since 3 December. Central bankers’ magic words caused those factors that had investors on edge in December (disappointing economic data and political uncertainties) to fade into insignificance in January.
Exhibit 1: Net rebound of equities in January (data as of 31/01/2019)
On top of assurances by the Fed and the ECB that they will proceed with extreme caution and ensure that the economy is sufficiently robust to bear higher key rates, there was better news on the trade front. The US and China resumed negotiations in late January, and reports emerged that kept hopes alive of an agreement that would end the tit-for-tat of higher tariffs and reprisals.
In the resulting lull, investors even managed to shrug off political uncertainties. In the US, the federal government shutdown lasted until 25 January, marking the longest ever partial shutdown. In Europe, despite Brexit developments that clouded the situation even further, investors currently do not favour the worst-case scenario, i.e., a no-deal Brexit. Although sterling gained ground, UK equities managed to eke out some gains in January.
There were no bad surprises in the latest corporate results. Earnings growth is as expected in the US (13% year-on-year) after slightly less than half of the S&P 500 companies have reported; in Europe, it is +4% by the Stoxx 600 and in the eurozone +3% by the EuroStoxx, where the reporting season is not as far along. But let’s not overlook the fact that analysts had cut their earnings forecasts on global growth concerns. Any “good surprises” here should be seen in perspective. Even so, earnings momentum did support equities.
Rising oil prices
Oil rallied. WTI (West Texas Intermediate) gained 18.5%, reaching a high since November, at almost USD 54/bbl at the end of January. This trend was driven mainly by supply-side news, rather than by a pick-up in demand. Saudi Arabia reduced its output in January and suggested that it could be lower than expected in February. OPEC output is estimated to have seen its sharpest monthly drop since January 2017. Political developments in Venezuela cut into its output, while US sanctions on the national oil company helped drive oil prices up. This rally proved to be especially good news for emerging equity markets in Latin America and emerging Europe. They outperformed the MSCI Emerging index (in US dollar terms) in January by far, gaining 8.7%.
Exhibit 2: Oil prices rally (data as of 31/01/2019)
Among major developed markets, the steepest gains were by US indices (7.9% by the S&P 500) and European markets (5.3% by the EuroStoxx 50), while the gains for Japanese stocks (3.8% by the Nikkei 225) were capped by the run-up in the yen late in the month. Markets posted gains worldwide in certain sectors, with cyclicals outperforming, particularly information technology, energy and financials.
Exhibit 3 : Sector performance in January (data as of 31/01/2019)
The Fed will be accommodating...
After their 29-30 January meeting, FOMC policymakers left the US federal funds rate unchanged. Such a decision had already been fully priced in after recent statements by central bankers had pointed to the Fed’s tentativeness on the appropriate pace of rate increases in 2019 in reaction to bourgeoning domestic and foreign risks. The communiqué and Jerome Powell’s tone following the meeting came off as quite dovish, officially confirming that patience would be necessary and flagging a pause in the tightening cycle. The Fed now considers that key rates have reached a range (2.25% to 2.50% since December) that can be considered neutral.
The other component of the normalisation of monetary policy was also raised. The run-off of the balance sheet, which began in October 2017, is still modest in scope (-USD 404 billion in Treasuries and MBS out of a total of USD 4 040 billion as of 30 January) and so far does not seem to have disrupted financial conditions. Even so, the Fed has been taken to task on this issue and had already raised the possibility of adjustments to its process. It clarified its forward guidance significantly on this issue in January, thus confirming a report a few days earlier in The Wall Street Journal.
The Fed said that run-off is no longer on “automatic pilot” and could be completed sooner than expected, as the targeted balance sheet would be “larger than in previous estimates”. From October to December 2017, the balance sheet shrank by just USD 10 billion a month. This amount has been raised on a regular basis and, since the end of 2018, has been capped at USD 50 billion (USD 30 billion in T-notes and USD 20 billion in MBS, proceeds from which are not reinvested upon maturity).
The government shutdown was suspended on 25 January, but still deprived the FOMC of several important economic figures, including the estimate of inflation as measured by the December PCE deflator. The consumer price index was released as expected and pointed to a slowdown in total inflation (from 2.2% to 1.9%), driven by falling energy prices and a stabilisation (at 2.2%) of core inflation (i.e. ex-food and energy).
Available data points to 2.5%-plus annualised GDP growth in the fourth quarter (after 3.4% in the third quarter). Net job creations were exceptionally high in December (312 000, raising the 2018 total to 2.6 million after 2.2 million in 2017 and 2.3 million in 2016). However, other indicators turned down, including some regional Fed business surveys and consumer confidence, which was probably hit by shutdown uncertainties.
Exhibit 4 : Stable US labour market (data as of 01/02/2019)Source: Bloomberg, BNPP AM
...But curb your enthusiasm
Growth concerns spilled over into January but did recede somewhat, thanks mainly to China’s announcement of monetary and fiscal stimulus and a fourth-quarter slowdown in GDP that was in line with expectations, and eurozone growth that was a little better than expected, despite further weakness in activity surveys.
Similarly, concerns subsided over the US-China trade dispute, as both sides seemed to want to use the December truce to resume negotiations and avoid new increases in customs tariffs and perhaps even to withdraw those that are already in place. These were two clear drivers of the global rally in equities, after they had priced in too much bad news in December.
However, the main reason for the rally seems to lie elsewhere. Comments from major central banks convinced investors that normalisation of G4 monetary policies would be more gradual than expected and might even be postponed.
Such hopes may be overdone, given signs that wages are beginning to accelerate and that growth should remain above its potential.
But these hopes could stabilise the market if they allow investors to await patiently for economic indicators to improve more convincingly and to begin to point to more solid global growth in absolute terms, after the slowdown from the exceptional expansion of 2017. Any dashing of these hopes could trigger increased volatility, as the very rapid rally in risky assets has produced technical configurations that are stretched in some cases.
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