Investors’ views on the market are being shaped by five key optimistic assumptions that may or may not turn out as they expect, according to Psigma Investment Management’s Thomas Becket.
Becket, Psigma’s chief investment officer, said investors were guilty of allowing assumptions on issues such as monetary policy, corporate earnings and geopolitics to guide their investment behaviour, even though some may be misplaced.
The first of the five optimistic market assumptions being made by investors is that the global economy is strengthening following fears of a weaker growth outlook towards the end of 2018.
“Clearly people have gone from thinking that the world was going to end and we were on the verge of a big recession to now believing what we actually saw was a mid-cycle economic slowdown and that the path of the global economy is likely to be higher as we move forwards,” said Becket.
However, investors convinced that the global economy is starting to recover might need to look again at the economic data.
For example, the most recent JP Morgan Global Composite PMI – an indicator of global economic growth – slowed to its weakest reading since September 2016 with rates of expansion easing in the manufacturing and services sectors.
Source: Markit
The trend in new orders will have to pick up substantially in the coming months, noted JP Morgan director of global economic coordination David Hensley, if global GDP is to recover to “a level more in line with expectations for 2019 as a whole”.
“Markets might want to believe that the global economy is starting to recover but, as yet, there isn’t any tangible evidence to suggest that is taking place,” added Psigma’s Becket.
Despite the strength of the US economy, he said data from Europe and Asia remains much weaker and makes it difficult to confirm whether the market slump is now over.
The second market assumption being made by investors is that monetary policy will be looser this year, which could act as a support for financial markets.
In January, the US Federal Open Market Committee announced that it would exercise greater patience in determining the appropriate interest rate level, following fears last year that the Feeral Reserve was ‘normalising’ and hiking rates too quickly.
The move prompted much relief in markets, which rebounded following a challenging end to 2018.
“The market now believes that the Fed has done an enormous ‘volte face’ and gone a complete 180 [degrees] from its position in December and that rather than going up in 2019, interest rates are either on hold for a long time or indeed the next movement could be down,” he said.
The Psigma investment chief agrees that the Fed was likely done with interest rate rises for the time being. In addition, the European Central Bank is unlikely to be in a position to ever raise rates and is more likely to engage in a further bout of quantitative easing.
“That could well be something that which helps financial markets continue to perform well in 2019,” he added.
Becket said the third assumption made by investors is that Chinese authorities will once again “put the pedal down to the metal” and create a lot of stimulus as was seen in 2015-2016, helping to boost its economy and – at the same time – global growth.
Quarterly GDP growth 2015-2016
Source: OECD
However, the chief investment officer said there were two reasons why the Chinese economy was unlikely to grow in such a fashion this year.
“One, the Chinese authorities are doing nowhere near as much stimulus as they were three years ago,” he said.
“The second dynamic is perhaps more important: the stimulus measures that have been put in place has done nothing to arrest the decline in credit creation in the economy and it looks to us that the authorities might well have lost control of China’s economic short-term future.”
The fourth assumption that investors are making is that a trade war between the US and China will soon be resolved, said Becket. However, here too, investors might be too optimistic.
Hopes were raised after the latest US tariffs on China were postponed for 90 days on 1 December, as both sides pledged to continue negotiations aimed at addressing trade issues.
The Psigma chief investment officer said it was unlikely that any deal struck between the world’s two largest economies would address long-term issues.
“We’ve always said there will be a trade deal, but we always said it wouldn’t be worth the paper it is written on,” the strategist explained.
“It might look like a good deal for Donald Trump and it might look like one for president Xi of China but it’s not going to be something that is longstanding or move the needle on global economic growth and global trade.”
While it is understandable that the markets have become more positive about trade given recent positive developments, said Becket, in the long term “something macabre has been let out of Pandora’s box” likely to have an impact on markets for the rest of the current decade and into the next one.
“The more concerning thing for investors is that what originated as a salvo over trade has now actually morphed into something out of control into great and longstanding concerns over national security which is going to rumble on for a long time still to come,” he added.
The final assumption made by investors is that global earnings will pick up this year, after an underwhelming 2018 during which expectations were massaged lower.
“In fairness to investors, you can say that low expectations have been beaten and weren’t as bad as many were expecting,” he said. “For now, we think that people are probably too optimistic in their outlook for corporate earnings and we’re likely to see adjustments lower than people’s expectations.
“That could well be some heavy treacle for people to move for as we move into the summer of 2019.”
Performance of MSCI World in YTD
Source: FE Analytics
Becket said after a troubled end to the year for markets, greater optimism has now taken hold. But while there are some grounds for a more positive outlook there are likely to be further challenges ahead.
“We believe that having seen really poor performance in equity markets in the last year and indeed the credit markets we saw a likely recovery in January in to the early days of February, we’ve now seen much more volatility,” concluded Becket.
“Probably, in the short term, people have become too optimistic and more volatility is likely as we move through the first quarter of 2019 and into the summer.”