New Year, Same Problems? Welcome To 2019

Authored by Michael Msika, equity markets commentators for Bloomberg

The market has started the new year the same way it ended the last one: erratic moves, fueled on one side by the biggest drop in U.S. ISM factory index since 2008 and a warning from Apple, and on the other side by the restart of U.S.-China trade talks, a cut in China’s reserve ratio rate and a blowout U.S. monthly job data. Fed chairman Jerome Powell put the cherry on the cake on Friday by raising the possibility of a pause in the central bank’s interest-rate hiking campaign and an alteration in its balance sheet reduction plans.

Investors have been selling all the bounces in stocks during the last quarter, a sign that confidence in equities is shaky, so we shall see if this new rally will hold. The Stoxx Europe 600 surged 2.8% on Friday, posting its best session since mid-2016, and Euro Stoxx 50 futures are trading 0.3% higher this morning ahead of the European open.

I often turn to credit markets to assess equity risk, and at the moment, they are not bullish. The iTraxx Europe has been unable to tighten durably and is still hovering near 90, even recording its highest print since June 2016 last week. It has been a good indicator of equity market direction in the past year, so keep watching that space. The one thing most strategists agree on is that volatility is here to stay.

We said it before, 2019 is not expected to be a walk in the park. Mark Haefele, Chief Investment Officer for UBS Global Wealth Management lays his 2019 base-case scenario this way: “Global economic growth slows but remains solid, while ongoing trade tensions, monetary tightening, and uncertainty about growth keep volatility high. Growth will slow and monetary policy will tighten, but a recession in 2019 looks unlikely.” He expects the equity market to return between 0% and 5% in the U.S. and in Europe this year.

Buy volatility spikes and sell the rallies in stocks is pretty much the strategy that has been working for a few months now.

This has clearly become a punters’ playground, with market timing becoming crucial. It even seems no one even cares anymore about the parliament vote on Brexit coming in less than two weeks, or the Fed policy. Surprisingly enough, the odds of a U.S. rate cut this year are now higher than a hike. That’s a big change in expectations given that policy weighed hard on equities last year.

So there should be hope for 2019. Intensifying trends and finding themes will be key.

Stephane Monier, CIO at Lombard Odier Private Bank, wrote in his 2019 outlook: “With risk assets now more sensitive to macroeconomic factors and political uncertainty playing an increasing role, volatility in market sentiment is here to stay. Nonetheless, there are reasons to remain cautiously optimistic: the New Year will begin with more favorable valuations and still-sound fundamentals.”

One interesting point in his 2019 outlook is about the U.K., highlighting the pound hovering near 20-month lows, he writes: “We believe that U.K. will avoid a hard or ‘no deal’ Brexit, because either Prime Minister Theresa May will eventually get an EU withdrawal agreement through Parliament, or the U.K. will unilaterally halt Brexit, perhaps following a second referendum. Both scenarios would be GBP positive.”

Those scenarios are also likely to be positive for U.K. stocks. The stronger pound might cap some upside in the short term but the removal of such an overhang for the economy would certainly benefit the country’s equities. The case for the U.K. might become more compelling, and for investors who like a good dividend yield, the stocks offer that. Looking at the yield forecast for U.K. shares, it’s standing at its highest level since April 2009