Perhaps many were those investors who had thought that Q4 2018 was the beginning of the next big recession. Well, following the end of Q1 2019, that seems to have been put on hold for a while, with investors’ optimism lifting the broader, fixed-income front into strong, single-digit gains, while most equity asset classes locking in double-digit advancements.
Unwise were those investors who have panicked and opted to peter-out at the bottom of the market correction last December. On the contrary, those who were brave enough to either hold or tap into the investible market against the downward trajectory which had gained quite a momentum at the time, must be quite pleased with the results witnessed over the three months that followed.
Let me recall briefly what exactly brought about the daunting market scenario of last year: the ongoing trade dispute and negotiations between the world’s two largest economies, the US and China; hawkish tone (or at least, less dovish tone) by the US Federal Reserve and the European Central Bank; and Brexit; all in the context of weaker global growth expectations as highlighted by various renowned international bodies such as the International Monetary Fund (IMF).
In fact, much of the positivity across most asset classes since the beginning of the year is a kind of knee-jerk reaction by financial markets expecting the US Federal Reserve not to raise interest rates further anytime soon, which was mirrored in Europe, with Mario Draghi, ECB’s president, adopting a more dovish tone too. Both Jerome H. Powell and Draghi, have revised GDP growth expectations further down to 2.1 per cent and 1.1 per cent, respectively.
One should also not exclude the possibility that the sharp decline across the US equity market itself in the previous quarter acted as a deterring factor to the US administration from hiking tariffs on China over the quarter any further.
This, combined with the March 29 Brexit deadline not being the actual deadline at all, are more or less the main contributing factors that buoyed the broader market throughout the entire quarter.
Nevertheless, interpreting how markets are going to react is never an easy task. This will prove to be even tougher going forward if one had to dig deeper and look into various economic data as highlighted hereunder, and which factors will have the highest weight in determining whether markets will be heading north or south over the months ahead.
The coming 18 months will be critical in determining the possibility of Donald Trump being re-elected as US President. On one side, some factors are at the discretion of Trump’s administration, namely the stance he intends to adopt in trying to solve the trade dispute with China.
On the other hand, whether the US Fed maintains the dovish tone markets are currently pricing in – with the possibility of a rate cut – is not (entirely) in control of the US President; I would not exclude a scenario where Trump exacerbates pressure on Jeremy Powell, chairman of the Federal Reserve, should the Fed decisions not please him completely, as we have already witnessed few months ago.
The coming 18 months will be critical in determining the possibility of Donald Trump being re-elected
Data suggests, as highlighted by an article in the Financial Times a few weeks ago, that there is an “extraordinary strong” correlation between an incumbent President’s win possibility and household economic confidence. Thus, maintaining consumer sentiment at high levels, whatever it takes, will probably be top on Trump’s agenda.
However, one may rightly ask, why should markets react the way they have reacted (positively) if markets are indeed expecting a potential rate cut, experiencing yet again, an inverted US Treasury yield curve late last month, where yields on longer-dated bonds are lower than those of shorter-dated debt?
Views among different market participants and economists may defer. One plausibility could be that this is a reflection of the fact that the Fed has for now refrained from raising interest rates further, and potentially, the eventual next move in rates could be down – but when to expect it is perhaps more of a rhetorical question.
One should remember that markets tend to always price (or at least try to) future expectations; and apart from growth expectations, which may have been subdued over the past year, interest rates themselves play a crucial role in determining the present value of future expected value.
Therefore, by implication, lower interest rates push equity prices and bonds (present value of future cash flows, which are inversely related to rates) higher. And yes, it does resonate with most of the 10-year bull market since the 2008 global financial crisis, with an extended period of low interest rates and quantitative easing fuelling most of the bull market.
Making reference to one other important economic figure, inflation rate, in the US has stood below the two per cent Fed target for most of the last decade. However, last February, a number of key officials from the Fed brought about arguments in favour of changing the way the Federal Reserve responds to inflation.
Rather than going for a tightening approach as soon as inflation rate hits the two per cent target, the benefits of accepting overshoots to the two per cent goal were highlighted, making up for times where inflation was too low. Such a consideration would portray an even rosier picture for the broader market from an interest rate perspective.
In Europe, the economic scenario seems to be even more bleak, particularly when looking at the manufacturing side. An economic health indicator frequently referred to, the Manufacturing Purchasing Managers Index (PMI), indicates the sharpest contraction in factory activity in six years, with manufacturing in Germany falling at the fastest pace since mid-2012.
On a more positive note, the services side of the economy remains rather resilient, with services PMI still in expansion territory and strongest in the past four months.
Unemployment rate remained steady at 7.8 per cent, whereas inflation figures hovered lower to 1.4 per cent. Once you weigh in all the uncertainty surrounding the Euro area, and adding to it the change in rhetoric by the ECB President in March to an even more accommodative one, as well as a less disruptive trade policy environment, these have all in all left a positive impact on the broader market.
Continued backing by central banks, a trade deal being reached between Washington and Beijing, together with a soft-Brexit scenario, could act as further support to markets throughout the second quarter. However, to what extent the manufacturing slowdown, particularly in Europe, could have an impact on both business and consumer confidence, makes it ever important for an investor to ensure proper diversification within his portfolio – not just by owning numerous investment securities, but by ensuring proper diversification in terms of sectors and asset classes.
This article was prepared by Colin Vella, CFA, head of wealth management at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail colin.vella@jesmondmizzi.com.