January this year was the best January for US equities (S&P 500) since 1987, and came on the heels of the worst December since 1931. The sharp turnaround underlines just how quickly investor sentiment can shift.
In our view, the equity price rises seen so far in 2019 have been fully justified. But on the other hand, prices have now reached a level where equities are no longer oversold and looking like a steal, as they did in late December. Equity prices rising further from here will require a new source of fuel. So what now for equities?
Tailwind factors for equities
We expect the equity markets will continue to enjoy a tailwind from the factors that have driven price movements so far this year. That is the main conclusion in our new Quarterly House View for Q2 2019. More specifically this means:
• We expect economic growth to remain solid and see no real prospect of a recession this year.
• We expect the US and China to hammer out a deal that will end the trade dispute.
• We see only a low probability of a hard Brexit with no agreement on future trading terms between the UK and the EU.
• While we expect monetary policy to be tightened, central banks will, in our opinion, proceed with caution in both the US and Europe so they do not choke economic growth.
• Economic growth has disappointed in Europe and China in recent quarters. In China, the government has begun to stimulate the economy, while in Europe we expect to see a more supportive fiscal policy that will help to stabilise growth.
• Finally, corporate earnings expectations are not as high as last year, which makes it easier for companies to surprise positively.
There are still substantial risks
Overall, we expect a return from global equities of 5-7% over the coming 12 months in local currency. Given our expectation of solid economic growth, we have difficulty envisaging lower yields in the time ahead, while monetary tightening should gradually push yields higher. We therefore expect just a modest return from government and mortgage bonds in the coming period, and so we continue to overweight equities and underweight bonds by an equivalent amount in our portfolios.
While we are generally positive on equity markets going forward, there are still substantial risks we need to take into account. For example, equity prices could suffer if, contrary to expectations, the trade dispute between China and the US does not ease further, the UK crashes out of the EU in a hard Brexit, or Donald Trump’s threat of a trade war with Europe resurfaces. We thus still see a risk of considerable market volatility.
Lower expectations can actually be positive
While the outlook for corporate earnings growth remains solid for 2019, we have seen a wave of downward revisions to analyst expectations. Yet lower expectations are not necessarily bad news, as more modest forecasts mean a lower risk of disappointment – and more opportunity for upside surprises.
A number of large stock market listed companies were suffering from a mismatch between expectations and reality towards the end of 2018. Many investors were looking for a further steady stream of better-than-expected results, while companies, in contrast, were beginning to tone down their forward guidance. Lower guidance came on the back of the many uncertainties that have dominated recently and which caused markets to go off the boil, but this means we are now very probably at a more sustainable level, with a better match between investors’ expectations and actual growth in company earnings in the coming quarters.
During the latest reporting season investors appear to have been satisfied with financial results that were unimpressive and simply ok, whereas last year this could have triggered very negative price reactions. This is a fine example of the wisdom contained in a classic quote from US investor Warren Buffet: The secret to happiness is having low expectations.
Disclaimer: Danske Bank has prepared this material for information purposes only, and it does not constitute investment advice. Always speak to an advisor if you are considering making an investment based on this material to establish whether a particular investment suits your investment profile, including your risk appetite, investment horizon and ability to absorb a loss.