Equity markets rebounded strongly in the first quarter of 2019, following the weak end to 2018. Concerns over US-China trade tensions eased and central banks became more supportive. Government and corporate bonds also rose due lower interest rate expectations.
A brief review of the major regions and asset classes:
US equities performed well as the Federal Reserve (the Fed) said that interest rates would rise more slowly due to the deteriorating economic environment, and the government shutdown came to an end. However, by the end of March, market momentum slowed as several indicators highlighted the slower economy. The growth reading for the last quarter of 2018 was adjusted down to 2.2% from the previous estimate of 2.6%, and the Fed lowered its projections. As a result, no further interest rate hikes are expected in the US this year.
In Europe, equity markets also performed well, although concerns regarding economic growth persisted. The eurozone grew by just 0.2% in the last quarter of 2018, with Germany stagnating and Italy slipping into recession. Forward looking data indicated further weakness, especially in manufacturing sectors. The European Central Bank (ECB) said interest rates would remain at current levels at least until the end of 2019.
In the UK, while Brexit related uncertainty and disarray dominated the news headlines, markets performed in line. Companies promising resilient earnings growth outperformed, in sectors such as technology, tobacco and beverages. In addition, the delay to Brexit beyond March provided hope that a crash out could be avoided, causing some domestically focused sectors to bounce.
The UK economy had slowed at the end of 2018 as Brexit related uncertainty impacted business sentiment, with growth decelerating to 0.2% from 0.7% in the previous quarter, although UK employment growth remains resilient. The Bank of England cut its growth projection for 2019 from 1.7% to 1.2%.
Asia & Emerging Markets
Equity markets in Asia and the developing economies rebounded strongly after the selloff in 2018. All Asian markets made progress, partly encouraged by improvements in US-China trade negotiations. The supportive rhetoric by major central banks also boosted sentiment, although global growth concerns remain a drag, with China’s economy growing at its weakest pace since 1990. The Chinese government lowered its growth target to 6-6.5% and outlined higher public spending and tax cuts, while the central bank provided further support by cutting the reserve requirement ratios for banks. China is expected to continue with supportive policies to offset the economic slowdown.
Elsewhere, a rally in the price of crude oil was beneficial for net exporter countries, such as Russia. Production cuts from OPEC and other oil producers, together with the implementation of US sanctions on Venezuela, served to tighten supply.
The promise of slower interest rate rises from central banks, combined with mounting growth concerns, to boost the demand for government bonds. The indication from both the Fed and the ECB that interest rates would not rise in 2019 helped government bonds rise, and corporate bonds performed even better.
At this point, it is worth taking a step back and considering the longer term picture. Over the past two years global growth has been the strongest since the start of the decade, but activity is now slowing, with the IMF now estimating the figure to be 3.70% in 2018, similar to 2017. Growth is expected to slow to 3.40% this year, with Europe being the most sluggish.
A key question is whether global growth can resurge. Some of the slowdown reflects temporary factors, such as the impact of the government shutdown in the US, whereas other factors are likely to persist, such as slower growth in China, and the fading effects of the US fiscal expansion in 2018. US-China trade tensions have eased, but some damage has been done, and the risk has not gone away. However, global markets are likely to continue to find support from the major central banks. Overall, a modest recovery is likely over the second half of 2019.
The risk of recession in the major economies remains low. If global growth does not stabilise, then there is a case for the Fed to lower interest rates, although clearly the ECB and Bank of Japan (BOJ) aren’t in a position to follow suit. In this scenario it is likely that fiscal policy will come into greater focus to help manage the next downturn. The Fed and other central banks may have changed their policy over the last 3 months due to the benign outlook for inflation. The Fed’s measure of core inflation has been at or below 2% for the last 10 years, and inflation has been extremely low in Europe and Japan. Central banks may now try harder to generate higher inflation and manage inflation expectations.
For the rest of the year, equity markets are likely to continue to be driven by sentiment regarding global growth and the economic cycle, central bank updates regarding interest rates and monetary policy, ongoing US-China trade considerations, and European politics… including Brexit.