Calm after the storm – or before a new one? After the volatility of late 2018, 2019 has proven much kinder to global risk assets thus far. Ironically, in our view it was precisely the severity of market concerns about US monetary policy and the US/China trade war in late 2018 that has since helped to forge more benign narratives on both key issues.
But from a multi asset perspective perhaps the most interesting development of 2019 so far has been the surge in risk assets alongside the stable performance of developed world nominal government bonds. If stronger growth expectations are supporting global equities, then shouldn't longer-dated nominal government bond yields be rising and yield curves steepening?
In our view, there is not necessarily something fundamentally contradictory in these developments. The reversal of fortunes in risk assets has come despite generally disappointing macro data across Europe, the US and China and, in aggregate, downgrades to forward corporate earnings expectations globally. In short, the rally in global equities in 2019 has not been driven by expectations for a better growth and inflation backdrop for corporate profits at all. Instead it has been driven by investors' clear belief that the near 30% derating in global equity PE ratios from end-January to end-December in 2018 was at least partly overdone, given that a number of major fears have now been at least partly allayed.
Whether investors' confidence to pay a higher price for lower earnings is warranted or sustainable are clearly key questions for the outlook for global equities for the remainder of 2019. We came into the year with a positive view on global equities after the Q4 sell off. We remain constructive. But the speed and scale of the rally in 2019 to-date has tempered to a degree the conviction of that positive view. Up 11.1% over the course of January and February, the MSCI World (USD) already delivered an above-average annual return in two short months. The likelihood of material further upside for risk assets in the short-term is, in our view, now dependent on the ability of ex-US demand growth to accelerate from current weak levels and on policymakers allowing financial conditions to remain loose. In particular, the effectiveness of the broad array of measures progressed by the Chinese authorities to cushion their growth slowdown remains critical.
Our base case is that overall global equity returns in the medium-term are likely to be positive but more muted than investors have been used to for most of the post-financial crisis period. Nonetheless, continued late cycle volatility and the broad array of macro thematic market drivers are making for a compelling tactical asset allocation opportunity set. In this issue of Macro Quarterly we explore in more detail those themes and the individual opportunities across asset classes globally.
Theme: Global growth around trend
The outlook for global growth momentum remains a key driver of asset classes. After the robust and synchronized growth of 2017, the rate of acceleration in global economic growth has moderated quite significantly over the past year. The major driver of the slowdown was the lagged impact of tightening financial conditions globally, but particularly in China, and as trade tensions impact business sentiment and investment.