Share markets started 2019 with three worries: First, the US Federal Reserve was tightening financial conditions as global economies showed signs of rapidly slowing. Second, China-US trade negotiation tensions appeared to escalate. Third, more specifically for the Australian market, the Chinese economy was slowing faster than expected.
However, these three risks started to abate in early 2019, underpinning the share market rally in most markets.
The Fed responded to slowing economic data by moving to a more dovish stance. The threat of a near term trade war escalation reduced, with China-US trade negotiations seemingly taking a more constructive tone. Finally, the Chinese government has provided stimulus to its economy to counter a disorderly slowdown. The evidence was seen in strong Chinese credit growth in January, which importantly underscores the Chinese political will to utilise available tools and resources to prop the economy.
What will determine the outlook from here?
Two factors could sustain the current rally.
First, the US Federal Reserve could turn even more dovish, and loosen financial conditions further – although we believe this is unlikely.
The second, and more plausible factor, is for global economic fundamentals to improve. Global growth momentum has started to show some improvements in February, following the slowdown experienced in the second half of 2018. Recent soft and hard data suggest modest improvements. Soft data, such as the Purchasing Managers Index (PMI) in all three major economic regions – China, the US and the Euro area – rose in February, leading the global PMI to increase by around 1 point. This was the first improvement since August 2018.
We note the PMI improvement was particularly strong in China—a critical cog in the global economy. This corroborates well with hard data such as investments in Chinese infrastructure and housing, which have also been improving.
What are the takeaways?
The change in central banks’ position on interest rates and financial conditions is generally supportive of risk assets. However, we don’t think central banks will move aggressively to ease any further.
A sustainable upturn in the global economy has a strong chance of supporting the current share market rally.
China appears central to the puzzle. The recent improvements in the Chinese domestic economy is positive but needs to broaden to areas such as private sector business investments. A trade deal between China and the US would also be positive, assuming the deal’s details are fair and preventative of further trade tension escalations. Chinese manufacturers should ease their pace of diversifying out of China.
In conclusion, recent policy developments in China and the US have improved the appetite for risk assets such as shares. While concerns still linger around the uncertainties and risks of weaker global growth there are signs of green shoots emerging to underpin stronger economies, which if allowed to bloom could sustain the share market rally into the year.
– ST Wong is CIO at Prime Value Asset Management.