After March’s disappointing data flow, April data has, for now, shown partial signs of stabilization, but at still weak levels.
After March’s disappointing data flow, April data has, for now, shown partial signs of stabilization, but at still weak levels. Retrospectively, this downbeat tone provides some justification for the extremely accommodative shift adopted by central banks. In Europe, The ECB announced a new wave of targeted longer-term refinancing operations (TLTRO) for banks, possibly at negative rates, while indicating that key rates would not rise this year. Across the Atlantic, the US Federal Reserve signaled its balance sheet reduction program would come to an end this September. The dot plot summarizing the expectations of regional governors for key rates now points to stability in 2019 (versus another two hikes last December), then a final hike in 2020. Against this backdrop, bond markets have benefited from a marked downturn in long rates since the start of the year.
Yet, we still believe economic growth could improve in the second half of the year. On top of the favorable accommodative shift in monetary policy, fiscal policies should also provide support, particularly in Europe and China. Hard Brexit worries have been pushed back for now, and if trade war worries were to ease, the equity market could benefit from strengthening economic activity. For now, the equity rally has simply corrected 2018’s downward excesses. Thus, equity valuations do not appear stretched. In fact, they are close to their long-term average (Forward P/Es), thus showing no excess. In addition, while earnings forecasts were still indulgent last year, there have been very clear downward revisions that leave room for potential surprises in Q2. Finally, positioning remains relatively light among market participants.
Overall, we continue to look beyond a potential short term correction risk, and still favor equity markets over sovereign bonds and still prefer Europe and emerging markets. We maintain our positions in high yield debt and remain underweight on sovereign bonds. We believe that long-term rates are currently excessively low. Positive surprises on growth could push these up, depressing the performance of the asset class. We have thus scaled down exposures in the segment and took some profit when the German 10-year yield again entered negative territory.