A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’
At the beginning of this year equity markets were reeling from a sell-off driven by fears over global growth and rising US interest rates.
It’s been a different story in the last half of 2019. Equity markets have soared with the MSCI global equity index up 14% so far this year and the US S&P 500 index hitting an all-time high last month.
Equities in most countries have risen in value with richer developed economies generally outperforming emerging markets.
In the UK the FTSE 100 of more international stocks has returned 10% in the last six months. Technology stocks such as Micro Focus and Aveva Group have done well as have mining stocks. Banks underperformed the broad market in the UK as in most other countries partly on the prospect of interest rate cuts and on growing competition from tech challengers.
So why, after a pretty awful performance in 2018, have equities have done well so far this year?
It’s certainly not because prospects for growth have improved – on the contrary, forecasts for global growth are lower today than at the start of the year. The decoupling of growth prospects from equity markets is most obvious in Italy, where equites have risen 16% this year despite growth almost grinding to a halt.
What has boosted equities is that the threat of higher interest rates has been lifted. Last autumn the Federal Reserve was poised to continue its three-year campaign of rate rises into 2019 and the European Central Bank had called time on its programme of quantitative easing. As growth faltered both institutions performed U-turns. The Fed now looks likely to cut US interest rates by 50bps this year and the ECB is talking of easing policy again.
The reversal of the direction of monetary policy has been a godsend for equity prices. They reflect the current value of future dividend income. Lower interest rates reduce the discount rate used in this calculation, raising equity values. For equity investors the good news on lower interest rates has more than offset the bad news on global trade and activity.
Sentiment about prospects for a trade deal has fluctuated. Hopes that the US and China would strike a deal buoyed equities in March and April. That optimism dissipated in May hitting US equities and helping push the price of gold, which represents a hedge against uncertainty, up by 12%. The latest news from G20 meeting in South Korea is positive, with President Trump declaring that he is ready to restart trade talks with China. However, with Mr Trump tweeting that “the quality of the transaction is far more important to me than speed…I am in no hurry” a trade deal is not a done deal.
Equity investors have had a great few months but they are becoming increasingly cautious. According to the BAML Global Fund Manager Survey money managers are cutting their holdings of equities and investor sentiment is at its most pessimistic since 2008.
Commodities have also tracked global growth fears, rebounding early this year before falling on worries over protectionism and global growth. Recent tensions between the US and Iran and supply outages elsewhere have caused oil to reach $67 a barrel, up 21% so far this year.
Many of the worries investors had in late 2018 have not gone away. The outlook for trade remains hugely uncertain and worries about global growth have mounted. UBS thinks global equities could fall by some 20% if there is no breakthrough between Beijing and Washington on trade.
What has changed is the mood music coming from central banks. Investors are hoping that, should things turn nasty, central banks will slash interest rates and save the day for equity prices.
Alan Greenspan, a previous chairman of the US Fed, has been heavily criticised for his policy of cutting interest rates in a market downturn – the so-called ‘Greenspan put’. Some believe this policy made investors blasé about underlying risks and paved the way to the financial crisis.
As central banks mull further interest rate cuts that dilemma remains as acute today as it was 20 years ago.
