Investors might be able to take a risk-off approach
The equity market bounce at the start of the year took many by surprise. The question is, does the rally have further to run in 2019, or should investors be using the bounce as an opportunity to take risk off the table? The answer lies in the root causes of the late-2018 sell-off and the turnaround we have seen since: the trade war and the US Federal Reserve.
In the final months of 2018, it became clear that the trade war was starting to have a global impact, slowing activity in Germany as much as China. At the same time, the Fed seemed oblivious to slowing global demand and intent on taking interest rates higher.
Investors have since become considerably more optimistic on both fronts. Following the G20 meeting in Buenos Aires, China and the US returned to the negotiating table in a bid to avert an increase in import tariffs from 10 per cent to 25 per cent on $200bn (£155bn) worth of goods on 1 March.
The Fed’s rate-setters have entirely changed their tone. Having spent the bulk of the October meeting discussing the degree to which rates should enter “restrictive territory”, the Federal Open Market Committee now believes it can be “patient”. Not only does it not see any clear need for higher rates in the near term, it has reassessed the extent to which it needs to reduce the balance sheet.
This change of Fed tone has been followed by a chorus of dovishness from other central banks, including the European Central Bank and Bank of Japan. The quantitative easing “punch bowl” may not be in the process of being taken away after all.
These two factors explain why equity and oil prices have been rising yet bond yields falling. Since the start of the year, the S&P is up 16 per cent, Brent oil prices 32 per cent, and yet the 10-year US treasury yield has fallen 13 basis points.
Given valuations in most stockmarkets are no longer as screamingly cheap as they were at the start of the year, any further significant upside is likely to require at least one of two things: the trade negotiations to proceed amicably towards a conclusion; and no wage, price or asset inflation to cause the Fed to reassert a more hawkish stance.
I am doubtful that the trade war is set to conclude. It may not boil over, but it seems highly likely to remain on simmer. Washington’s concerns are not limited to whether China’s tariffs or approach to intellectual property are appropriate and fair. They extend to China’s industrial strategy. Both governments essentially wish to dominate the fast-growing global tech industry (the US for security reasons as much as economic).
The US therefore takes offence at the state-directed support China provides for its fast-growing tech industries under the umbrella of the China 2025 industrial strategy.
China, by contrast, believes such support is required to sustain the development of its economy away from agriculture and low-value-added manufacturing.
On this matter, there seems no scope for common ground. Washington may also shift its focus to European auto tariffs as the year progresses.
Beyond these specifics, it is clear the “America first” agenda still has tremendous electoral support and is likely to remain the backbone of president Trump’s 2020 campaign.
Deadlines for further action may therefore be postponed, but a full and complete resolution looks highly unlikely.
Global capex is the victim of a simmering trade war and in turn the length of this expansion.
With labour markets increasingly tight in much of the developed world, investment is needed to lift productivity and extend the cycle.
But global investment intentions are falling rapidly, including in the US. Our researchers compile an indicator of global capex intentions.
This has turned down sharply in the past six months and is now pointing to an outright contraction in global capex spending this year.
The Fed may then find it hard to justify a dovish stance if the lack of slack in the US labour market feeds through into further wage and price inflation. Within last week’s bumper earnings report from Walmart were signs that retail pricing power is returning.
While the Fed has implied it might be willing to tolerate a bit of inflation to show it is symmetric around its 2 per cent target, the combination of rising price inflation and significant asset price inflation could raise questions about the credibility of the institution under an administration that prefers low interest rates.
This year could well feel like a re-run of 2018. Early optimism felt in the first quarter could peter out, leaving us with significantly more bumpy markets for the remainder of the year. Investors would be advised to take advantage of the opportunity afforded by the equities bounce and adjust to a slightly more defensive, globally diversified portfolio, favouring value and quality stocks, and alternative strategies that can help hedge against volatile equity markets.
Karen Ward is chief market strategist for EMEA at JPMorgan Asset Management