New article from Tatton Investment Management: Central banks disappoint expectations

7 May 2019

Last week we wrote that stock markets faced being challenged by the decline of a number of stimulating aspects that had been regularly named as the drivers of the 2019 recovery. The most crucial one being central banks’ assurances that they would refrain from further monetary tightening and might even consider renewed rate cuts.

No wonder then that the past week began with weaker trending stock markets as everyone was waiting with bated breath for the latest policy announcements by the central banks of the US and UK. Better-than-expected European and US economic growth (GDP) rates had already raised the prospect that further monetary support might not be forthcoming. This was precisely what happened. Rate-setters at both the US Federal Reserve (Fed) as well as the Bank of England (BoE) ‘disappointed’ any remaining expectations of forthcoming rate cuts. Indeed, BoE’s Mark Carney went as far as suggesting capital markets were mistaken in only pricing in a single 0.25% rate hike for the next two years.

The fact that stock markets took the news in their stride and actually regained ground towards the end of the week will have disappointed all those who had suggested the 2019 recovery was merely a function of a return of central bank support. The remarkable aspect of the week’s dynamics from our perspective was that the economic data was not in any way positive enough to compensate for the loss of further central bank easing prospects.

It would seem that investor sentiment has improved so decisively since the turn of the year that confirmatory evidence that the global economy is not slowing further is sufficient to keep investors interested. Yes, corporate earnings growth has inched back above the 0% line, but at an annual growth rate of 3% it is a far cry from last year’s double digit pace. Forward indicators of economic activity in the form of PMIs are at best stabilising at low levels, and GDP growth has only recovered to very pedestrian rates of around 2%, which we used to dismiss as stall speed.

The crucial point is that this is enough to underpin the expectation of continued economic expansion – albeit at a once again slow speed – rather than to suggest a looming recession. Such an environment is sufficient to allow companies to continue to grow their profitability and thereby make money for their shareholders. This re-establishes the benign environment for risk asset investors where the big question is not to worry about the return of capital but focus on where the best returns on their capital will be achievable in 2019.

Here the debate continues to rage at to whether the US stock market will be able to continue to reward its investors with significantly higher company valuations relative to their ongoing earnings than elsewhere. In this respect it is interesting to observe that year on year earnings growth in Europe is currently running at exactly the same rate as in the US: 3%. Perhaps the fact that over the past weeks the US market has no longer led the rest of the western world is an indication that market leadership is slowly changing.

To close this week’s summary with a more domestic observation, we found it very notable that our most reliable ‘Brexit-Barometer’, the £-Sterling currency market, reacted remarkably strongly to the poor performance of the Conservative and Labour parties in the UK’s local elections. £-Sterling has reached its highest level against the €-Euro for a year, so it may be tempting to purchase one’s holiday currency before currency markets change their minds about political weakness making an imminent agreement on a Brexit deal more likely.

 

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