In this month's edition:
Is now the right time to buy equities?
Optimism over US-China trade talks and more dovish Federal Reserve have helped lift global stocks from their Christmas Eve lows. But we still need to see concrete movements on several fronts before we call the rally sustainable: comprehensive progress on trade, renewed earnings momentum, and data confirming our view that the current economic soft patch is only temporary.
Did you know?
We expect the US-China trade conflict to simmer in 2019, with small improvements avoiding further tariffs but no lasting resolution.
Staying invested is important. In the postwar era, the S&P 500 has delivered positive returns 2.3x more often than negative returns over six-month periods, and 5.8x more often over five-year periods.
At its lowest closing level on Christmas Eve, the S&P 500 had fallen 19.8% from the last all-time high set in September. Following the last such sell-off—a 19.4% peak-to-trough drop in 2011—the index rallied 28.6% in the next six months.
Is the Fed tightening cycle over?
The Federal Reserve's monetary policy stance has shifted from "autopilot" to "patient," raising the question of whether the central bank has finished raising rates in this cycle. Rates continue to be the main policy tool, and Fed statements and commentary suggest the cycle has paused rather than ended. We expect the Fed to deliver one further 25-basis-point hike later this year.
Did you know?
30 January was the first Fed meeting day on which the S&P 500 rallied since Jay Powell became Fed chair, following losses after seven straight meetings.
It was the best “Fed day” performance since December 2014, when the Fed also added a reference to being “patient” to its statement.
Economic cycles are often ended by central banks overtightening. But this risk appears to have receded after Powell said that rates are "just below" neutral.
Over the last 30 years there have been four tightening cycles – in 1988, 1994, 1999, and 2005. The fed funds rate went up by 300 basis points on average in these cycles within the space of one or two years.
Can China and the US resolve their trade tensions?
Simmering trade tensions have been a major preoccupation for investors. US trade relations with China remain especially fragile, even after an agreement at the G20 conference to de-escalate the conflict. In addition to the feud with China, the US continues to threaten higher tariffs on auto imports, which if implemented could hit Germany and Japan especially hard. But while a renewed trade escalation remains a risk, there are promising signs that President Trump is willing to compromise and is not impervious to the economic impact of his trade policies. Markets are also supported by continued economic growth and rising earnings.
Did you know?
NAFTA is the most important trade issue in terms of its direct impact on the US economy. US exports to China totaled about USD 32bn in 1Q18, versus USD 137bn of US exports to Canada and Mexico.
According to Nobel Laureate Michael Spence, "the old model we had in the postwar period was based on a critical assumption, which is that developing countries including China would become like market economies. That’s not going to happen. The Chinese are going to have a different system with a much bigger state presence in their economy."
Among Chinese listed stocks, international sales make up a low-teens percentage of total sales, of which the US accounts for 20%. This implies that their direct sales exposure to the US is around 3%.
Could a Eurozone recession derail markets?
The wait for a recovery in the Eurozone has been frustratingly long. Italy has lapsed into recession while the German government has sharply scaled back its growth forecast for this year. As a result, markets are not pricing any rate hikes from the European Central Bank (ECB) until the middle of 2020. Despite the weakness, we don't see the Eurozone lapsing into recession. The ECB remains supportive, unemployment is low, and the housing market is strong. So we don't currently expect a Eurozone recession that could undermine global stocks.
Did you know?
The Eurozone Economic Surprise index stands at –79 for February, down from +5 in September. This indicates that economic releases have failed to meet expectations.
But Eurozone unemployment has fallen to 7.9% for December, close to the all-time low of 7.3% hit in 2008.
Eurozone inflation remains low, with core prices excluding food and energy rising just 1.1% for January. While this is partly a symptom of lackluster demand, it means there is little pressure on the ECB to tighten rates prematurely.
Will UK Lawmakers approve a Brexit deal?
The outcome of the Brexit negotiations remains highly uncertain. After suffering a crushing parliamentary defeat, but surviving an opposition no-confidence motion, UK Prime Minister Theresa May presented amendments for Plan B, which was not substantively different from the original proposal. As a result, the UK's future is wide open. The chances are rising for a delay, a general election, a second referendum, or even no Brexit at all. With the outcome uncertain, we prefer stocks that could navigate any Brexit scenario well.
Did you know?
The proportion of UK exports going to the EU has been declining. In 2016, it was about 43%, while 54% of UK imports came from the EU. Without a trade deal, UK exporters would face GBP 5.2bn in tariffs on goods sold to the single market, while EU exporters would face GBP 12.9bn in tariffs on the reverse trade, according to estimates by Civitas.
In a UBS Industry Leader Network survey, the majority of business leaders felt that the EUUK economic relationship will remain largely unchanged during the Brexit transition. But some have already noticed changes in business activity, with multinationals internally restructuring and shifting orders back to local markets.