Global Weekly: What lies ahead?

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The earnings season is well underway and what we have seen so far is a bit wobbly. Most companies show reasonable results and many companies have done better than analysts expected. But, many earnings estimates had been lowered in recent months. It’s not easy to predict the market… but we can try.

There was tremendous market volatility in 2018, and there is no reason to expect it to be much lower in 2019. Most investors are aware of the risks. These include the trade dispute between the US and China, Brexit, lagging German economic activity, the Italian budget controversy with the EU and the economic slowdown in various regions. There could also be other issues that are not yet visible. However, all of the current issues could be resolved. For example, with a good Brexit deal, a pick-up of German car manufacturing or a workable trade deal between the US and China.

The S&P 500 Index stands at 11% below its all-time high and 11% above the low seen in December. The question is, what happens next? A test of the high or a test of the low? While we cannot know for sure, we can look at what happened in the past. The market has had three similar examples of panic-selling, such as occurred in late December. These periods were in August 2015, July 2002 and May 1962. Each of these examples were followed with a lower low and by a double-digit positive return over the following 12 months.

Another study shows that two ‘10:1 up days’ (days where for every 10 stocks that rise, one stock declines) are typically followed by strong market performance over the following six months, albeit in 80% of these cases, the market tested a low during that six-month period. This low typically occurs within the first two months of the period. (Data from Ned Davis Research.)

While there is no fundamental argument here, for investors it may signal a time to be cautious. In January, we moved from an overweight to a neutral allocation to stocks.

A silver lining for risky assets in bond markets

The US Treasury market is aware of the recent shift in the balance of power in Washington. It occurred when US President Donald Trump had to retreat from his dispute with the Speaker of the House of Representatives, Nancy Pelosi, over funding to build a wall along the Mexican border. As a consequence of the power shift, it will likely become more difficult to trigger additional fiscal stimulus when the economy slows. Following this reasoning, it can also be expected that the Fed could be forced to become more accommodative (dovish). The most recent press conference by Federal Reserve Chair Jerome Powell confirmed a more patient stance toward rate hikes. However, for ten-year US Treasury yields to increase significantly above their recent resistance level of 2.80%, inflation needs to rise, which is currently not the case.

The dovish tone of the US Fed should, in general, continue to support risk sentiment in bond markets, especially in emerging markets, as relative yields are still attractive. Credit spreads should also benefit in the near term from the current signals, despite some headwinds, such as a slowdown in US corporate earnings growth, still tighter financial conditions, a slower growth environment and persistent political risks.

In the eurozone, the concern that the end of bond purchases by the European Central Bank would make it more challenging to issue bonds was refuted this week. Austria, Belgium and Greece entered the fixed income market and issued sovereign bonds, with a combined issuance amount of EUR 12.5 billion. Order books, however, were in excess of EUR 65 billion. Ten-year German government bond yields, currently at 17 basis points, are probably pricing in too many negative surprises.

This gives room for a positive surprise, as trade negotiations between the US and China have entered a crucial phase. This upside potential is also valid for the US Treasury market. A final trade deal by the end of the second quarter is still possible. A key motivation for a deal on the US side is the presidential election in 2020.