What future for the equity rally?

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The global equity rally extended into April, with the MSCI AC World index (in USD terms) up 3.2% over the month as the pace of gains accelerated relative to the advances seen in March. The global benchmark surpassed its early October 2018 level, thus reversing all of the declines in last year’s fourth quarter.

  • New records for the US S&P 500, Nasdaq composite
  • Investors reassured about the shape of the world economy
  • After the lows of March, the pressure on long yields has been contained

Good news on many fronts

The main equity markets did well in April. However, emerging market equities underperformed slightly (the MSCI Emerging gaining only 2% in USD) despite the chunky 6.3% rise in WTI oil to USD 63.90. Crude rose as the quotas set by OPEC and its partners to reduce production were respected better. Also, political tension in Venezuela weighed on production, as did US President Trump’s decision to end the exemptions on oil imports from Iran. Surveys showed that OPEC production was the lowest since 2015 in April.

As has been the case so far this year, equity markets were supported by the still accommodative stance of major central banks, signalling interest rates will remain low. In addition, investors were reassured by improving economic indicators (particularly in China and the US), which helped dispel the spectre of a global recession. These factors largely overshadowed the IMF’s downward revision of expected global growth in 2019 from 3.6% to 3.3%, with the accumulation of better-than-expected data eventually convincing investors that the low in activity had passed.

Eurozone growth rebounds

Activity surveys were mixed in April. The ECB said it still saw risks to the outlook for the eurozone as it depended on global growth momentum, but we believe central bank action can wait thanks to inflation remaining low (1.4% YoY; 0.8% excluding food and energy, in March). GDP growth came in at 0.4% in Q1 after 0.2% in Q4 2018. The breakdown is not yet available, but GDP growth in France, for example, holding at 0.3% for the third consecutive quarter, showed a slight pick-up in final domestic demand excluding inventories. The figures exceeded the market’s expectations based on purchasing managers’ surveys and corroborate the improvement in actual production and consumption seen in March.

equity GDP PMI

Business growth is on the rise

The latest corporate results were also generally favourable, with earnings growth exceeding (modest) expectations in the US, where the Q1 reporting season is the most advanced and managers appear to be fairly confident for the rest of the year.

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The generally buoyant environment allowed investors not to worry too much about outstanding issues, particularly political ones. While the deadline for the UK’s exit from the EU was extended by six months, talks between UK PM Theresa May and the Labour opposition have so far been inconclusive, leaving Brexit in a state of abeyance ahead of European Parliament elections this month. On the trade negotiations front, China and the US continued to talk and hint at progress, but more needs to be done before an agreement can be finalised. At the same time, President Trump has not hesitated to reassert that Washington may also target trade with the EU.

As investors focused on the good news and shrugged off the potential risks, the main developed markets posted solid monthly gains (in local currencies): 4.9% for the EURO STOXX 50, 3.9% for the S&P 500 and 1.7% for the Topix. At a global level, technology, financial and cyclical consumer goods stocks posted the biggest increases.

Cyclical sectors benefited from the sunnier economic setting. Eurozone banks were supported by the view that the ECB would implement measures to limit the cost to the financial system of the negative deposit rate. In the US, large banks posted results that exceeded analyst expectations, even though some segments did worse than expected.

More defensive sectors such as healthcare or those depending on the direction of long yields (utilities, listed real estate) lost ground globally. In Japan, the gains came mainly from industrial cyclicals and export-related activities on the back of brighter Chinese growth which should benefit Asia as a whole.

‘Goldilocks’ is feeling a little weak

After the fourth consecutive month of equity gains, and the 15.2% rise in the MSCI AC World (in USD) since the start of the year, one could question the nature of this rally and its possible course. Most assets have risen since January, with investors looking again at a particularly favourable ‘Goldilocks’  scenario, where everything is ideal for equities and bonds alike: economic growth is sufficiently stable and solid and the absence of inflationary pressures is allowing loose monetary policy to remain loose.

Life is not a fairy tale, and there are many risks, both downward and upward, to this idyllic environment.

  • On the one hand, the cycle looks fairly advanced, but the global economy is not immune to destabilising shocks (a slowdown in China or Europe; political and geopolitical events).
  • On the other hand, as growth in the US exceeds potential and wage rises are beginning to accelerate, the Federal Reserve may be forced to raise key rates sooner than it sees fit and, above all, sooner than observers anticipate.

In both cases, investors would have to rethink their equity and bond positions, causing volatility to rise.

The pressure on long yields in the first half of April, after the very low levels reached at the end of March, could be the first indication of such a reassessment, but in our view, their subsequent easing shows that it is difficult to reach a consensus at this time. The timidity of investors to participate in the equity rally also illustrates this wavering.

‘Goldilocks’ may still prevail for some time, but it remains fragile. In this context, flexibility and reactivity are required when allocating assets, whether through monitoring market sentiment indicators or implementing positions that allow market asymmetries to be exploited.

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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

 

Nathalie Benatia

Macroeconomic Content Manager

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