The first quarter of the year saw one of the strongest starts for the equity market since the financial crisis. The MSCI World index gained 12.7 per cent in the first quarter of 2019, the best return posted by the index since the crisis. In Europe, the STOXX 600 gained 13.3 per cent in the first quarter of the year, which was only bettered in the first quarter of 2015 (1Q15) (+16.8 per cent) since the crisis and the best for the S&P 500 (+13.6 per cent) over the same period.
In truth, equities have recovered some of the steep losses suffered in the last quarter of 2018. December was one of the worst on record, the second worst for the MSCI World (-13.3 per cent compared to -21.6 per cent in 4Q08), STOXX 600 (-11.5 per cent compared to -22.1 per cent in 4Q08) and S&P 500 (-13.5 per cent compared to -21.9 per cent in 4Q08) since the financial crisis in 2008. Investors were skittish about the global macro outlook and the impact this would have on corporate earnings and valuations.
The equity market reacted positively to improved news flow on the possibility of a trade deal between the US and China over the past months. In our view, a deal is now largely priced in by the market even though no concrete deal has been announced as yet. Additionally, 2019 saw the return of the FED put, with the FED’s policy shifting to a more accommodative stance supporting higher equity valuations in the process.
Overall, the macro situation remains challenging. Last week the IMF cut its forecasts for global economic growth to 3.3 per cent in 2019 (down from 3.7 per cent forecast in October), the lowest since the global financial crisis. The expected growth in 2020 was revised downwards to 3.6 per cent from 3.7 per cent forecast in October. The IMF expects the global economy to pick up in the second half of the year, supported by monetary policy accommodation, fiscal stimulus in China and an improved outlook for trade tensions between the US and China.
Going forward, we are less confident about the outlook for the equity market performance over the next nine months, especially in Europe. The continent’s economic performance continued to deteriorate in 2019, with the ECB staff projections pointing towards a sharp recovery in the second half of the year. This however does not take into consideration the possibility of the US imposing tariffs on car imports, an important sector for the region. In our opinion the economic outlook would be revised significantly lower in the event of an escalation in trade tensions between the US and EU.
Besides this, Europe faces a new round of parliamentary elections to be held between May 23 and 26. The indication so far is that eurosceptic parties will make significant gains in this year’s elections, but not enough to form a populist majority. Opinion polls are still showing a mainstream party majority, with the European People’s Party (EPP) expected to get 25.2 (down from 29.4 per cent in 2014) of the votes and the Socialists & Democrats (S&D) 19.4 per cent (down from 25.4 per cent in 2014) (Source: Politico).
On the other hand, eurosceptic parties are expected to get 21.8 per cent of the votes, up from 15.5 per cent in the 2014 elections. A fragmented Parliament will impact key EU appointments (for example European Commission President) and reform progress. Populist gains could add to the uncertainty surrounding the region, especially in places like Italy (65.8 per cent), where indications are that populists will gain a majority.
On balance, we expect low equity market returns from here with risks tilted to the downside. Equity investors will likely continue to focus on earnings growth, which are expected to slow down significantly in the current year. Risks remain tilted to the downside in view of the possible US-EU trade talks, possibility of disappointment over US-China talks, valuation levels and the macro-economic outlook.
Notwithstanding, the recent central bank dovish tone has pushed sovereign yields lower, forcing investors to once again start looking to the equity market for some yield.
This could provide some support in the near term but the risk of a policy misstep continues to rise.
The current bull market is now the longest in history (for the S&P 500).
Robert Ducker is an equity analyst at Curmi and Partners.
This commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.