More needed before we call the equity rally sustainable

Thought of the day

by Chief Investment Office 08 Jan 2019

Chinese Vice Premier Liu He, the top economic advisor to President Xi Jinping, unexpectedly attended trade talks with the US on 7 January, according to Bloomberg reports. The talks, the first face-to-face Sino-US meeting since the G20 meeting, were slated to be led by lower-ranking officials. Liu’s appearance is a sign that China is placing greater importance on reaching a deal to diminish trade tensions.

The S&P 500 rose 0.7% on 7 January, helped by the news.

But we still need to see concrete movements on a number of fronts before we are confident that the equity rally will prove sustainable:

  1. US President Donald Trump has said the “talks are going very well,” while China’s foreign ministry has said that China is willing to resolve its disputes with the US on an equal footing. More conciliatory rhetoric is encouraging, but both parties need to make meaningful progress in the trade talks ahead of the 2 March deadline.
  2. The equity market reaction to the December rate hike was the worst since 1994. Interviews with Federal Reserve Chair Jerome Powell and Cleveland Fed chief Loretta Mester helped spur the equity market rally late last week, as they signaled policy flexibility. This week, the minutes of the Federal Open Market Committee (FOMC) meeting in which the Fed raised rates will be released. Markets will also be eager for guidance from at least five other Fed officials speaking this week for more signs that recent market slides have reduced their enthusiasm for further rate hikes.
  3. Sentiment is still fragile, with the US government partial shutdown entering its third week. An end to the political dispute would help reduce one source of uncertainty, while persistently better economic data (like last week's US jobs report) should help lift sentiment, too.Against a backdrop of attractive valuations, we think an overweight to global equities is warranted with counter-cyclical positions to help navigate the volatility of the current market environment. Investors who can implement options should consider purchasing protective put options on the S&P 500, sized to hedge a fraction of the portfolio's equity exposure.

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