January was one of the best starts for US equities since 1987, with solid gains of +7.87% for the S&P 500. This, however, was still not enough to clawback all the losses from a turbulent December 2018, one of the worst Decembers in history (-9.2%), but the “V” shape recovery is fascinating. What is the rationale behind such a drastic reversal? One of the most logical explanations is linked to the Fed. Indeed, after the bloodbath on equities indices last year, Jerome Powell capitulated at the last Fed meeting by marking a policy U-turn from hawkish in December to dovish in January, mentioning that patience is required before even contemplating the next interest rate hike. This shift in monetary policy has been more than welcome for risky assets, as the likelihood of a US economic recession in 2019 vanished. Moreover, Fed’s Chairman eased investors’ minds about the Central Bank “Put”, which seems to remain alive, for now.
Does this signal the comeback of the “goldilocks” scenario, a friendly environment (such as 2017) for risky assets where economic growth remains steady with limited inflation pressures? There are some reasons to be sceptical. Global growth forecasts have been revised down, with the IMF slashing its estimates by 0.2% compared to October 2018, from 3.7% to 3.5%. Moreover, some countries are already on the edge of a technical recession, particularly in Europe. Germany will not be shielded from this situation and the latest PMI numbers were underwhelming at 49.5, entering contraction territory. The picture might be brighter in the coming months as positive effects from a lower EUR and oil prices might support growth, but overall, we remain in a deceleration path. While inflation expectations faded on the back of this economic slowdown, US wage growth remains elevated and might put the Fed in a difficult situation in the second half of the year should the economy show signs of recovery, as the market is not pricing any rate hike for the current year.
One consequence of this weak economic backdrop is the increasing risk for earnings disappointment in 2019. US EPS growth expectations have been already trimmed to 6% from 10% a few months ago, and the tone of the forward guidance remains downbeat.
Moreover, the MSCI all countries index rebounded by more than 14% since the Christmas Eve trough. Consequently, we remain cautious in our asset allocation and prefer to avoid being overweight in equities. We believe the current equity rally is offering a good opportunity to lock in some profits and to hedge portfolios as the agenda of the coming weeks will likely fuel some renewed volatility (Brexit negotiations, US-China trade negotiations).