Investors entered the new year nervously, whiplashed by one of the worst months for stocks in a decade and wary over the global economic slowdown. The first batches of economic data from China and the US were disappointing, stirring concerns that 2019 might continue where 2018 left off.
But after a brief wobble, some welcome calm has returned and buoyed markets once more. The FTSE All-World index fell the first two days of 2019, but has now notched up five straight days of gains, extending its bounce since the Christmas Day nadir to almost 8.5 per cent.
There are several drivers of this shift in sentiment. Positive signs on US-China trade talks, growing expectations that the US Federal Reserve will pause rate hikes and favourable corporate earnings predictions have all helped breathe fresh optimism into the market.
But the biggest factor may simply have been that investors became far too pessimistic in December, when markets were beginning to price in the possibility of a painful economic downturn in 2019. When people realised that was still very unlikely, a rebound was natural, according to Sean Darby, global head of equity strategy for Jefferies.
“We’re set up in global equities for a rally simply because the position has become very risk averse,” he said. “It makes me think of the old saying ‘Be fearful when everyone is greedy and greedy when everyone is fearful’. Well now everyone is fearful, I feel you should be going back and putting lots of money into equities.”
The trigger, however, was clearly the combination of strong US employment data — which assuaged concerns that the economy was weakening sharply — and Fed chair Jay Powell backtracking on his more hawkish comments. Last week he stressed that the central bank would be “patient” in tightening monetary policy and opened up the possibility that the central bank could tweak its “autopilot” policy of shrinking its balance sheet.
The more cautious stance was then reinforced by a series of other dovish comments from Fed officials over the past week. The release on Wednesday of minutes from the December meeting indicated that still-low inflation and choppy financial markets meant that “many” policymakers thought the Fed “could afford to be patient about further policy firming”.
As a result, the S&P 500 has jumped 10 per cent since its December low, with economically sensitive sectors such as household appliances, energy and homebuilders rocketing higher. But the rally has been broad. Of the 3,195 members of the FTSE All-World index, more than four-fifths have seen gains in January.
“Powell changed his tune, and people feel more comfortable now,” said Adam Sender, chief investment officer of Sender Company & Partners, an asset manager. “People were offside and got extremely bearish, and now we have the snap-back.”
Valuations now also look more attractive, especially if growth remains resilient. The twin impact of lower oil prices and US workers receiving higher returns after income tax reform, will inject up to $170bn to the pockets of US consumers, UBS estimates. This should stave off fears of a US recession and boost cheap, growth-sensitive cyclical stocks, argues Keith Parker, the bank’s head of US equity strategy.
“I think the cyclicals would be very mispriced and you’d get a recovery in broader cyclicals — financials, industrials, materials. That would lead the market and reverse the defensive positions we saw in 2018,” he said.
However, the nervousness that spread across markets in 2018 is far from dispelled, with many analysts and fund managers still cautious on the coming year. John Chatfeild-Roberts, head of strategy at Jupiter Asset Management, said the recent bounce was nothing more than a “bear market rally” that would ultimately fizzle out.
“Nothing goes down in a straight line,” he pointed out. “The underlying issues, from rising interest rates, quantitative tightening and overall debt levels, are still with us. Until the Federal Reserve changes course, expect more downside and then a new bull market, possibly later this year, but from lower levels.”
Indeed, while many fund managers are anxiously waiting for clarity on the US-Chinese trade talks and the upcoming earnings season — which kicks off in the US next week — the Fed’s deliberations may be the deciding factor for markets in 2019.
The strength of the US economy will guide the Fed’s decision on monetary policy but, given its influence over global interest rates, the consequences would echo everywhere. And the recent market stability could put higher rates back on its agenda.
Most economists have pencilled in two more rate increases this year, but the Fed funds market indicates that traders think the central bank is most likely to stay on hold through 2019. The implied odds of a solitary rate increase are roughly the same as for a rate cut.
Jonathan Golub, chief US equity strategist for Credit Suisse, still reckons markets will enjoy healthy gains this year, but warns that if the Fed turns hawkish again then it could undermine the recent stability.
“I think if the Fed starts to signal to the market that they’ll move again, I think the market is going to be extremely unhappy and I think the Fed will get a bloody nose,” he said.