After the sharp rise seen so far in 2019, the markets now seem to be at a crossroads. While caution is still required, it's a good idea to remain invested, says Gilles Prince.
For the third time in 2019, stock markets are close to their record levels for recent years and some are even hitting historic highs. Most indices have more than made up for their losses in the final quarter of 2018 and are up once more by nearly 20%.
The trend for bonds, meanwhile, is also continuing with outstanding gains this year both in terms of price and the number of securities providing negative returns. Even gold seems to be out of the doldrums having gained 15%. In fact, achieving poor absolute performance in 2019 would be quite a feat.
While performances in the current year resemble those seen in 2017, this year is quite different from the Goldilocks situation prevailing at that time. For instance, we are seeing increased volatility, greater sensitivity to news stories and more frequent reversals of trends both for stock markets and the major central banks' monetary policies.
Lack of alternatives
The conflicting news relating to Brexit, China-US trade negotiations and the unstable situation in the Middle East has had an impact on investor sentiment by spreading temporary panics, but ultimately very little impact on index levels.
Each correction has quickly led to a return to the highest levels, although indices have struggled to surpass these for long. Central banks have played a not non-negligible role in these rebounds by relaxing their monetary policies - key rates were reduced nearly a hundred times worldwide in 2019 - thereby providing a floor for each crisis.
It should also be noted that structural demand for equities remains high due to the lack of alternatives. Share dividend rates are indeed staying broadly higher than bond yields in most regions. Corrections are therefore viewed as buying opportunities.
The market's positioning is defensive, though, and few people are promoting an overweight position in equities. Fundamentally, there are reasonable grounds for cautious positioning, as we are witnessing a slowdown in global growth to levels at which growth becomes more vulnerable to external shocks.
Manufacturing sectors are suffering (and there may even be reason to fear that they could pull services down with them), China's economic engine is slowing down, and geopolitical uncertainties remain high, creating a manifest lack of visibility. A certain dichotomy can therefore be seen between economic conditions and stock market performance.
Having said that, these factors are well known and priced in. The big questions are what might rekindle the growth outlook and how to push equities to higher levels in the long term. Initial support would be given by better visibility in terms of the economic outlook, which would reassure
both companies and investors.
The finalisation of a deal between the European Union and the United Kingdom or ratification of a partial trade agreement between China and the US are two examples of such positive factors. But reassurance is not enough.
A fiscal stimulus policy in Europe, and even in China, would give greater weight to monetary policies which may be accommodative but are running out of steam. A decisive announcement on European fiscal policy seems unlikely in the short term and implementing such a policy would be yet another hurdle.
Negative factors that could tip the scales include downgrades of global economic growth and leading indicators continuing to point south (in China, for instance). Even a simple tweet could undermine the fragile progress towards partial resolution of the trade dispute between China and the United States.
Ultimately the markets seem fragile and at a crossroads whereas stock market indices are close to their highest levels. Reducing the equity allocation may seem reasonable in order to take profits for the year but, in view of the above, this may represent an opportunity cost.
So we intend to remain invested. Sector positioning and active management of the correction risk, particularly by using derivative or structured products, will make all the difference.
Gilles Prince is chief investment officer at Edmond de Rothschild (Switzerland)
Sector positioning and active management of the correction risk, particularly by using derivative or structured products, will make all the difference.