Sentiment in sharemarkets turned ugly towards the end of 2018, led by the US where share prices fell by almost 20 per cent. Many investors and commentators predicted a long and deep slump in share prices.
The selldown was short-lived — and a strong rebound followed. By late February, the Dow Jones Industrial Average index of US shares had risen for nine weeks straight — the index’s longest winning streak since May 1995. Here, average share prices were, at time of writing, 13 per cent above their December low point.
Recent months are a reminder of how dangerous it can be when investors simply go along with the prevailing sentiment in financial markets; at times, taking a counter view enhances returns.
Could the positive sentiment in sharemarkets build up further over coming months; and, like the gloom it replaced, become overstated? I think the answer to both questions is yes. Let’s look at the key influences recently driving the wide swings in investor confidence.
1. US monetary policy
Late last year, many investors and commentators expected the Fed would raise its cash rate two or three times in 2019 — and fracture the 10-year-old US economic upswing.
Instead, the Fed blinked. It scrapped its assessment that the US cash rate was “a long way below the neutral rate” (the rate that keeps the economy in good balance), and committed to be “patient” in making changes to the cash rate. It also announced a scaleback in the sales of bonds it had acquired during and after the global financial crisis.
As the Fed chairman said to the US senate: “We view current economic conditions as healthy and the economic outlook as favourable, (but) over the past few months we have seen some cross currents and conflicting signals.” He cited a tightening in financial conditions, weaker global growth particularly in China and Europe, and the ongoing trade negotiations; also, US inflation has remained low.
Other central banks — including those of the eurozone, China, the UK and Australia — also indicated (though in different ways) they’d prolong the accommodative settings in their monetary policy should economic conditions weaken.
The recent rethink on the outlook for monetary policy will probably provide some further support for shares and bonds over coming months. But investors need to remain alert.
- Inflation may not remain as low as it’s been — particularly in the US, where wages have been trending gently upwards for a couple of years. At the least, investors should allow for repeats of the experience of February 2018, when a monthly inflation number above expectations brought on a sharp sell-off of shares and bonds.
- There’ll come a time when high and rising levels of indebtedness become a big concern — and cause turbulence in financial markets.
- With economic growth slowing, some investors now expect central banks, including in the US and Australia, to cut their cash rates in a year or so. If that view proves to be correct, equity investors would need to revise down their expectations for corporate earnings.
2. China
To limit China’s cyclic slowing, the central bank there has eased financial conditions; and the central government is starting to increase spending on infrastructure (though, as yet, on a much smaller scale than in the fiscal boosts in 2008 and late 2015). Credit in China expanded by 11 per cent in the 12 months to January, after a 33-month slide; this closely watched statistic has played a role in the worldwide recovery in investor confidence.
In my view, China will continue to deliver better economic management than most Western observers usually predict. But investors need to allow for recurring concerns in financial markets that China will tip into recession; and to bear in mind the longer-term consequences for China of rapid growth in indebtedness while domestic savings fall.
3. Tariff wars
Late in 2018, investors were also preoccupied with the damage that could result from the tariff wars. More recently, reports the US and Chinese trade negotiators were moving towards a deal to forestall another round of tit-for-tat tariff increases helped rebuild confidence in global sharemarkets.
Again, investors need allow for the return of nervous and disruptive times. President Donald Trump repeatedly argues the US trade deficits with individual countries result mainly from “unfair” trade policies — but so long as the US continues to invest much more than it saves, the US is destined to run a sizeable trade deficit with the rest of the world.
Moreover, establishing and maintaining effective control against intellectual property theft is daunting. As Martin Feldstein, an experienced adviser to US governments, warns: a deal to contain technology theft would initially be welcomed in markets; but if it did not solve the problem, it could not be seen as sustainable.
Don Stammer is an adviser to Altius Asset Management and Stamford Brown Financial Advisers. The views expressed are his alone.