Over the course of the first quarter of 2019, global equity markets have made a sharp, V-shaped recovery from the late 2018 meltdown. While world economic growth is still decelerating, green shoots of expansion have emerged. In most geographies, fiscal policies have turned more countercyclical – less austere, in other words – supportive of continued economic growth. In the US and Europe this year, there will be less focus on deficits and debt. China has stepped up efforts to offset the impact of trade frictions by cautiously easing monetary policy, but aggressively loosening fiscal policy. Moreover, central banks are no longer in “tightening” mode, most important of which is the US Federal Reserve. Politics, however, remains a wild card – Brexit is looming.
As of the end of the quarter, the 29 March deadline for Brexit was missed. Deal or No Deal still remains the question. Fatigue has set in from almost three years of Parliamentary debate. Angst, shock, opprobrium and ridicule fill the air.
Nonetheless, the FTSE 100 is up 30% since 22 June 2016, the day before the Brexit vote, in total return terms (i.e. including dividends), to the end Q1 2019. Many will argue this is due to large multi-nationals hardly being “British” companies; the plummeting pound helps their repatriated profits. Inconveniently for that line of argument, the FTSE 250 – more suitably “domestic” – is up 21% in that time. It is all-too-easy to draw the conclusion that one’s asset positioning should be defensive during times of heightened conflict or stress. However, financial history teaches a different lesson: geopolitics rarely impact equity markets over the medium to long term, with recent events further supporting historical precedent.
Indeed, equity markets stand at, or close to, fair value across most regions and markets. This leaves us more sanguine on equities than other asset classes, with the view further bolstered by a supportive policy mix, an improving growth outlook, growing corporate earnings and price momentum back into positive territory.
On the other hand, expected returns for government bonds are set to be low, if not negative, this year. Tame inflation and signs of weaker growth have pushed major central banks nearly everywhere to halt normalisation. Long-term yields have tumbled. Some better macro readings as well as a possible rise in inflation could well fuel a recovery in yields, denting bond performance.
Still, risks to equities exist. Politics risks could spike, while macro momentum could worsen on the back of trade frictions and declining business confidence. Any of these could result in a resumption of downtrend, challenging our sanguine view on equities. As always, our investment process seeks to evaluate long-term fundamentals rather than focus on short-term movements, and looks to longstanding drivers of asset returns: valuation, momentum, sentiment and the prevailing macroeconomic regime.
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