In response to a multitude of global economic and financial vulnerabilities at hand, several major central banks capitulated early on this year and adopted an increasingly dovish stance – which has ultimately diffused the crisis in confidence and translated into a revival in risk appetite in 2019, leading stock markets higher.
This pivot from the central banks has improved the visibility of the economic cycle and reduced the probability of recession – which suggests that equity markets have reason to continue their march higher.
Already, global equity markets have recalibrated and posted some impressive (and in some cases, record-breaking) results as the dovish turn from central banks and some encouraging signs of progress towards a trade deal between the U.S. and China rekindled investor sentiment. Moreover, some preliminary signs of a stabilization in global growth and healthy corporate earnings results have also given investors reason to cheer. Taken together, these developments point towards a reasonably bright investment landscape for the rest of this year.
Global economy: Reflationary impulse drives 2019 reacceleration
It would appear that the cautious rhetoric from central bankers has evolved into a self-fulfilling prophecy that has brought into question the sustainability of the global economy itself. However, we believe that investors remain too bearish on the state of the global economy and that fears of recession are largely misplaced at this time.
Instead, we expect the global economy to find a floor and reaccelerate through 2019 – particularly if the external forces that have been weighing on sentiment dissipate. Specifically, the combination of diffused U.S.-China trade tensions and a policy-induced stabilization in China should prove sufficient in reigniting the global economy.
Indeed, there are reasons for optimism. The March manufacturing survey results in the U.S. and China staged a comeback and are both firmly in expansion territory, with robust factory activity in the world’s two largest economies set to bolster business conditions for the global economy more broadly.
In Europe, there are some preliminary signs that the worst may be behind us. Economic results have improved marginally over the last month and we expect growth to revert back to a respectable pace as the transitory factors that were weighing on the economy fade.
Finally, the latest string of upbeat activity data out of China suggests that the plethora of monetary and fiscal stimulus efforts may finally be proving successful in stabilizing the world’s second largest economy and by extension, the global growth trajectory.
Bond yields: Dovish expectations set the stage for a hawkish surprise
We believe that the latest slump in global interest rates is not justified in an environment where the ingredients for a severe global deceleration (and recession) remain largely elusive. Investors remain too sanguine on the path for inflation and interest rates in light of a healthy and above-trend growth trajectory, with bond markets now positioned for the worst case scenario (and are discounting rate cuts).
As such, the bar for a hawkish surprise from central banks remains low – particularly if inflationary pressures reassert themselves and bring central banks back to the table in late-2019 as we expect. Encouragingly, labour market trends remain healthy, with rock-bottom unemployment and rising wages likely to place upward pressure on prices – compounded further by the environment of higher crude prices.
In our view, the path of least resistance for interest rates remains higher. In this environment, we expect yield curves to steepen. While we expect only modest re-pricing at the short-end of the curve as central banks gradually normalize policy, a revival in inflation expectations is expected to place upward pressure on the long-end of the curve.
Equity markets: Further upside in 2019
Equity market gains this year have been driven exclusively by multiple expansion as headline risks pertaining to global trade retreated and the accommodative message from global central banks led investors to bid up what they were willing to pay for equities. In contrast, earnings detracted as concerns about a pronounced economic slowdown fuelled downward revisions to earnings forecasts at the beginning of the year.
Looking ahead, we expect equity upside to be driven by a combination of multiple expansion and earnings growth. Notably, the “sweet spot” of supportive central bank policies and tame inflation should help to nurture the economic recovery and drive multiples higher, while earnings momentum should improve on the back of a revitalization in global growth. With so much pessimism on the economic outlook, the bar is low for an upside surprise to earnings forecasts and accordingly, equity prices.
Candice Bangsund is a vice-president and portfolio manager of global asset allocation with Fiera Capital Corp.