Last year ended with a terrible month of December, which was one of the worst on record. Donald Trump's unexpectedly aggressive attitude to America's trading partners, especially China, rattled investors - while building wage pressures and a hot running economy pumped by Trump tax cuts prompted the Fed to tighten monetary policy. In addition, Chinese growth was decelerating at an alarming rate.
Recent experience often exerts a disproportionately strong influence on opinions. Most investors, judging by the raft of end-of-year strategy pieces from analysts, expected a poor start to 2019.
Embracing uncomfortable positions
It is not easy to be contrarian. People are, at heart, pack animals, who prefer the safety of a crowd. There was a strong urge to sell stocks and wait for a better second half of the year. Hope lay in the narrative of a difficult first half of the year, rescued by a more benign second half. If bound in to stock markets, the temptation was to seek safety in defensive, economically-insensitive stocks, and to avoid areas of the world that felt the most uncomfortable - emerging markets and North America.
However, the correct thing to do was to think differently, embrace the anxiety of others and stay in stocks - especially the more stressful ones.
Global equities returned almost 10% in Q1, in sterling terms, which was a pretty stellar quarterly return. The best kinds of stocks were either the most unloved from the last quarter of 2018, or those with high growth and scarily-high valuations - both anxiety-inducing in their own way. The best hunting grounds for a stock picker were North America and emerging markets - where an equally-weighted index outperformed an index weighted on market cap. Just about every market produced good returns, even bonds.
Yet, this was against a background of pitifully little ‘good news'. Most of the quarter's performance occurred while corporate results were generally below expectations and marginal economic data was disappointing. So, what has changed to allow such a dramatic release of investor anxiety?
The unexpected release of anxiety
In 2018, investors did not like the combination of slowing growth and a cautious, tightening Fed. One has changed, and it only needed one change to release anxiety. The Fed unexpectedly reversed course early this year, signalling a clear intent to put further interest rate raises on hold for the rest of the year.
This Fed shift, a perception the Fed would be just as responsive to signs of economic weakness as strength, had a profound impact. It has seemingly shifted the investor focus from poor near-term news, to a belief the worst has passed. The effects are seemingly contagious. Whereas the Chinese policy response to slowing growth was generally viewed suspiciously last year, it has been embraced as likely to be effective this year.
The third pillar of 2018 anxiety has also begun to fade. Rhetoric from Trump has softened on trade with China, as he pushes for a favourable resolution. A China-America fixated view has seemingly blinkered investors. Events in Europe and recent corporate earnings trends from Japan have been largely ignored.
Economic news out of Europe has been fairly dire. Italy, France and Germany are all teetering on the edge of recession. Brexit is unfolding into a kind of slow-motion trade war. Political discord seems to be mounting. Japan has its own problems. It is more sensitive to global growth. Profit expectations had rebounded during February, like the rest of the world, but have been deteriorating through March, signalling that trouble may be brewing.
Investors focusing on the wrong areas
It seems to us that investors are looking for risk in the wrong places. We believe investor views are overly focused on a China-America axis. Trump wants a trade deal and so does China. The easy win is for China to favour American imports, especially in commodity areas, to help reduce the trade imbalance - something Trump has explicitly targeted.
The easiest way for China to achieve this is to crowd out trade with other non-US trading partners. Europe and the more resource based emerging markets look most vulnerable.
China and America may experience a gradual release of trade tension and a benign environment for growth for the rest of the year, but the rest of the world may not be so lucky. Risks are mounting for the second half of the year.
Jeremy Lang, partner and co-founder of Ardevora Asset Management