Magazine Issues » May 2019

Markets: A most unloved bull market

BullFund managers sound optimistic about a continuation of the market rally, given improving economic prospects in the US and China. And there’s plenty of cash on the sidelines that missed the rally, says one.

In April, the S&P 500 reached a record high. Ritu Vohora, investment director at M&G, describes this as a new milestone for the “most unloved bull market in history”.

“With the stock market so distrusted by many investors, and positioning so defensive, the latest record for the index is perhaps a pyrrhic victory. But since the beginning of this current bull market, just over ten years ago, the S&P has delivered a total return of 436%,” she said.

Drivers that have contributed to the record high include the huge amount of well-documented central bank monetary stimulus over the past decade. But beyond this, there has also been a flight to ‘bond proxy’ stocks following record low bond yields, and a boom across the technology and consumer discretionary sectors, which in total return terms were up 698% and 786%, respectively, Vohora noted.

However, the key questions are about whether this bull market has longer to run, and to what extent the current raft of US corporate earnings announcements will point to a further slowdown in growth, she said.

“For now, the US Federal Reserve’s reversal on interest rates, from aggressive tightening to a willingness to be more flexible and data-dependent, has created a risk-on framework for equities, while in bonds, the recent inversion in the yield curve, indicating fears of a recession, seems but a distant memory.”

A “becalmed” US dollar provides a positive backdrop not only for US equities but for emerging market equities too, Vohora suggested, adding that despite the record high for the S&P 500 index, global stocks continue to look attractively priced relative to bonds. The equity risk premium – the difference between the earnings yield on stocks and bond yields – stands at 5.7%, which Vohora says more than adequately compensates investors for the additional risk they require to hold equities.

Three factors
The record high in the S&P comes as wider markets have rallied, too. Rupert Thompson, head of research at Kingswood, said the rally has three drivers. Again, these include the marked shift in Federal Reserve policy, but he also highlights the potential of a US-China trade deal and hopes that the decline in global growth will soon bottom out.

“Until recently, hopes of a stabilisation in growth were based primarily on the shift in Fed policy and trade talks rather than any hard data. However, this has changed in the last few weeks with recent economic numbers now clearly pointing in this direction.”

Chinese growth stabilised in the first quarter, seemingly responding to recent policy stimulus, said Thompson. More importantly, given possible official manipulation of the GDP numbers, the economic numbers for March have been “encouraging”; and there were signs of business confidence levelling out in the Eurozone, which has been hit hard by the slowdown in global trade over the past year. Back in the US, estimates for first-quarter growth have been rising steadily and are now “a respectable annualised 2%, versus under 1% earlier in the year”.

“All this leaves the rebound in equity markets looking rather more justified,” he added. “While a melt-up in equities – as recently predicted by BlackRock CEO Larry Fink – to our mind continues to look rather unlikely, markets could well hold on to recent gains. Even if equities don’t see any further price gains, they have some attraction just because of their dividend yield.”

As an illustration, the FTSE 100 in April was paying a dividend of 4.3%, well above the 1%-2% returns available for UK investors from cash or gilts, Thompson said. Kingswood planned to add to its equity exposure, including allocating more money to the US, where the risk of recession has significantly fallen and where the firm has been running a sizeable underweight.

Animal spirits
Mark Dowding, head of developed markets at BlueBay Asset Management, said if equities move through their highs and global central banks are easing financial conditions at a time when the growth outlook is starting to improve, “it is possible that animal spirits push in this direction over the months ahead”.

In the US, despite recent scare stories, growth could continue as economic conditions remain supportive. First-quarter GDP growth “now seems likely to exceed 2%”, based on the most recent Nowcast estimates.

“Even though Q1 was a disappointing quarter, impacted by the government shutdown and negative seasonal effects – which have seen Q1 GDP average just 1.5% over the past five years, when Q2 growth prints have averaged 3.6% – we believe that growth over 2019 as a whole can exceed 2.5%, with above-trend growth continuing to push the jobless rate even lower,” added Dowding.

US rates have “re-priced meaningfully” in the past several weeks as recession fears became priced out. However, markets continue to discount monetary easing later this year and into 2020 when this currently appears to have “little merit or justification”.

But Dowding was also warning in April that the positive response of the Chinese economy to stimulus could see the authorities there halt further stimulus measures: “Chinese figures for industrial production and retail sales gave further confirmation of a growth rebound, though at the same time suggested that monetary authorities in Beijing could stop adding further stimulus, with the economy already having benefited from prior policy action.”

Chinese GDP for Q1 came in at 6.4%, and defied bearish expectations, said Craig Botham, emerging markets economist at Schroders. It surprised most economists, but there is a risk that stronger manufacturing growth was due to a “frontloading effect” ahead of tax cuts in April, he added. In other words, manufacturers may have increased orders and production in anticipation of making money from lower VAT rates. The trouble is, this could soon unwind.

“If we were to sound a note of caution, it would be to note that GDP was supported by an acceleration in the manufacturing sector, which offset slowdowns elsewhere in the economy. There is a risk that this is a frontloading effect triggered by the April tax cuts and so unwinds next month. Overall though, this month’s data should still serve to ease fears over China’s impact on the global economy, even if imports are still weak.”

GDP was not the only data to surprise in April; industrial production in particular “blew expectations out of the water”, but Botham is sceptical, saying an increase in the numbers was difficult to explain.

Year on year, production grew 8.5% compared to 5.3% for the combined January-February period and was the strongest since 2014. But this did not square with reduced domestic demand.

“For us, the difficulty lies in reconciling weak domestic demand as evidenced by contracting imports with the story told by surging industrial production. Credit data has been strong, but it is too soon to expect it to show up in activity data, particularly as lending to the real economy seemed to slow in January and February and only picked up in March.

“Either imports or industrial production must therefore be wrong in their signal on domestic demand.”

For weak imports to be consistent with strong domestic demand, this would suggest that China has managed to shift supply chains onshore. China is indeed doing this, but Botham doubted whether the pace of change could prompt such a sudden and dramatic disconnect, given that imports and domestic demand were much more closely related until April.

It’s possible that something is amiss in the industrial production numbers, he said. “It is curious, for example, that industrial production should be so strong and yet manufacturing investment should slow. The implied increase in capacity utilisation would be expected to see capacity expansion under normal circumstances – that it has not suggests manufacturers do not see this as a sustainable increase in production.”

Botham and his team were “somewhat sceptical of the sudden spring in China’s step” and saw a strong possibility that some of this strength in production would be undone in May. “All the same, this is a stronger than expected GDP print. We still expect the strong credit data to result in a pick-up in growth in the second and third quarters, so there is some upside risk to our expectation of 6.3% growth for 2019.”

China’s economic situation and US Fed policy are underpinning expectations in some quarters that the equity markets will continue to rally.

Recession “nowhere in sight”
Esty Dwek, senior investment strategist at Natixis Investment Managers, said “green shoots” were visible in the the global economy, whereas recession was nowhere to be seen.

“While data remains mixed, we are starting to see some green shoots in the global economy and we continue to believe we are nowhere near a recession. We expect a stabilisation in growth to materialise in the coming quarters, led by a stabilisation in the US and China, where data is already pointing to improvement,” she wrote in a report.

In her view, the equity market rally will continue, albeit at a slower pace. Markets are coming around to a more optimistic growth outlook, supported by dovish central banks and improvements in US/China trade.

“Nonetheless, short-term corrections are likely, as is higher volatility even as markets grind higher in the coming months, because plenty of risks remain (European growth, Brexit, US debt ceiling). We also believe that fundamental support from decent earnings growth will be necessary to support an ongoing rally.”

“For now, though, inflows have been timid – so plenty of cash remains on the sidelines having missed the rally, which should help keep corrections relatively shallow and short-lived,” Dwek added.

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