New article from Tatton Investment Management: Waning market stimuli put stock markets on notice

29 April 2019

A pleasant Easter break has been followed by new highs for US equity indices. And yet, it has been a less comfortable week for professional investors. The tailwinds blowing the 2019 stock market bounce-back are waning. Rebounding bond yields have made corporate borrowing a little less cheap than it was in Q1; oil prices – climbing on supply fears rather than demand pull – are creating a strain for economic activity; and an unexpected step up in the value of the US$ is equally concerning for emerging market $ borrowers, as it is for $ denominated global trade volumes. And the major central banks of China and Europe have been indicating no great inclination to loosen monetary conditions further.

To be sure, the recovery of risk assets from the lows of Christmas 2018 still looks rational. The backdrop is that the global economy is slow rather than recessionary. Valuations have risen but are still at levels which do not require anything more than muted economic growth. As long as bond returns remain low, even slow earnings growth will keep valuations in line with historical averages.

We have written before that investors can look beyond a not-so-great quarter for corporate earnings results, as long as the medium-term outlook (over the subsequent quarters) remains positive, or central banks deliver more liquidity. This week’s economic data may be indicating limited headroom for growth optimism later this year. Unless the prospects for the second half of 2019 stop undermining the fundamental support of earnings growth expectations, further increases in stock market prices will depend yet again on the weary central banks.

At the moment, the warning signs are not flashing. But the more pronounced they become, the greater is their ability to sour investor sentiment and reverse the private sector risk-appetite that has propelled markets since the start of the year. For the moment, corporate earnings for Q1 2019 are better than anticipated and management outlook statements no worse than neutral. The positive news flow stimulant should continue for another couple of weeks and markets should remain stable. However, should the current deterioration of the medium-term outlook persist, then a bout of market volatility may well be on the cards.

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