Back in 2017 we viewed it as a year of solid gains in equity markets and an exceptionally – if not eerily – calm market environment. We concluded in January that while equities were expensive, relative to their own history, there were likely more gains to come in this secular equity bull market. That remains broadly our view today but we recognise that the risks we referred to for some time have had greater impact this year and market sentiment has taken a knock from trade-war concerns. For now our bias remains to add to risk during any periods of market nervousness but as ever we will adjust and communicate our view if the evidence changes.
It has been an unusual equity bull market in that there has been little evidence of euphoria despite the longevity and scale of the advance. We seemed to have experienced low level anxiety throughout the move and now transitioned to late cycle volatility and a heightened state of nervousness. It’s akin to experiencing a mild hangover without having enjoyed the long party. It’s at times like these we need to step back and try to distinguish signals from noise in the markets.
For the first half of the year global equities for a euro investor gained 2.75% and just over 1% on a local currency basis. These were modest returns and perhaps disappointing given the broadly positive backdrop at the beginning of the year. Indeed some markets and sectors have experienced much greater volatility and are in negative territory for the period; Chinese equities for example, experienced a conventional bear market, falling almost 25% from their January high to current levels.
But the backdrop has changed since the start of the year in a number of respects. The US will experience some additional tightening of interest rate policy than previously envisaged, European politics have emerged again as a reminder of Europe’s structural challenges and there has been a significant escalation in trade policy differences between the US and other countries, with significant measures being announced by the US administration.
The trade piece is the new factor which has spooked investors. What is true is that markets are not factoring a full scale trade war and that economic growth, company earnings and equity market returns could be materially impacted if that were to arise.
That is as close to fact as we get in markets. What is conjecture is whether this will come to pass. The US has certainly upped the ante significantly and approved some anti-trade measures. Our current belief – as evident in our asset allocation positioning – is that all sides will recognise that in a world of global companies and interconnected supply chains, it is much more difficult than previously to direct measures against other countries than do not also impact your own country, even if we ignored the likelihood of retaliatory measures.
Given the structural nature of globalisation and its long term impacts, anything that undermines it has to be taken seriously and may indeed be a signal event for markets.
For now we continue to monitor and analyse our current belief, in particular whether feedback from companies to governments has any impact on the rhetoric used and actions taken. Also we need to be careful about ‘catastrophising’ the situation and focusing only on risks, and we should be cognisant of equity market valuations being somewhat lower than at the beginning of the year
On the other hand, bull markets do not have to end in high valuations and euphoria, governments do not always behave optimally when it comes to trade, and central banks can make policy errors and tighten policy too much, with impacts on credit and equity markets. It’s also true that we can have cyclical equity market corrections within medium-term positive structural backdrops
For now we think that some of the more supportive equity market factors that have been in the background in the past few months may reassert themselves and anxiety may dissipate. We will focus on the balance of evidence including market reaction and look to participate in the next significant move in markets.