Helped by a shift to more accommodative central bank policy and positive rhetoric surrounding a US-China trade deal, global equities have rallied 18% since their December lows. They are now less than 2% below their all-time peak in US dollar terms (4.5% in local currency terms).
But a lot of good news is now priced in. The balance of risk-reward has changed at the margin, and we think it’s prudent to take some profit after this run-up:
- Markets appear to be pricing in a revival of global growth after a recent soft patch along with low inflation and no rate hikes. Global growth expectations have rebounded sharply according to the BAML global fund manager survey, and fed funds futures are pointing to a rate cut in the next 12 months. Bonds have also rallied. US 10-year Treasury yields have fallen by a further 17bps this year, and are almost 75bps below their October peak, while 10-year German bund yields have fallen back to zero. That raises the question of whether a “goldilocks” scenario is priced in for bonds as well as equities.
- The Federal Reserve has delivered another dovish surprise, but markets appear to want more. The Fed has cut its forecast for rate hikes this year from two to zero and announced it will end its balance sheet run-off in September rather than next year. Fed Chair Jerome Powell stated in his press conference that current data does not point to a rate move in either direction, but markets are pricing a cut.
- Markets appear to be taking a successful outcome to US-China trade talks for granted as well. Chinese stocks, which are highly sensitive to the result of the talks, have been the best performing market this year, with the Shanghai Composite up 24%, roughly twice the rise in global stocks. And US industrials, a sector that is also sensitive to trade conditions, has outperformed the S&P 500 by over two percentage points this year. We see a 60% probability of a deal that partially resolves the dispute. But regardless of whether an agreement is reached, the deep-seated, longer-term nature of US-China rivalry is likely to continue to be a source of periodic volatility, and should temper any market enthusiasm in the event of a trade deal.Against this backdrop, we have reduced our equity exposure. We remain risk-on through our overweight in more cyclical equity markets, in our relative value trades, and our overweight in emerging market USD sovereign bonds. At current levels, we would like to see more confirmation that growth and inflation have stabilized before we increase risk. Given the low volatility that “goldilocks” has presented us, we have also tightened our downside protection by rolling up the strike price on our S&P 500 put position.