Global markets reach record highs: what next?

The year 2019 was not without wobbles. The US-China trade conflict was a persistent worry, with President Trump frequently turning to Twitter to escalate the rift. Over the summer, there were worrying signals from the bond market. Yields on government debt fell to record lows, as investors became pessimistic about the long-term outlook for growth and inflation. A little later, markets took fright at the inversion of the US yield curve (a technical measure which has historically been a recession warning sign).

The story today is very different. Investors are confident that at least a partial trade deal is close at hand.

This prompted an improvement in the outlook for global growth over the last quarter of 2019. Combined with supportive monetary policy from the world's central banks, this has left equity markets in a buoyant mood, with US stocks continuing to lead the way.

On balance, we are comfortable with this more constructive outlook. However, we are sticking with a “neutral” view on equities. Two reasons for this more cautious stance are valuations and over-optimistic forecasts for 2020 earnings growth. While stocks have been rising, earnings forecasts have not. This means shares have become more highly valued over the course of the year.

Cause for concern?

Share prices have risen, but earnings have not

^{Source: Cazenove Capital, Datastream, December 2019}

The cycle continues

We think the global economy is stabilising as we head into 2020. Manufacturing remains weak, but there are tentative signs of recovery around the world. For the first time this year, the Schroders’ economics team upgraded its global growth forecast for 2020 to 2.6%, from 2.4%. The size of the change is small, but the shift in direction is important. Growth is stable, rather than on a downward trajectory.

It looks increasingly as if the slowdown that started mid-year was a trade war wobble, rather than the start of something more significant. We recognise that this takes the current economic expansion to unprecedented lengths. However, it is important to remember that this has been a shallower expansion than previous ones.

As I have said before, expansions do not die of old age. What usually brings an economic cycle to an end is overheating. And while parts of the stock or credit market have looked frothy in recent years, there has been little sign of excess in the real economy.

In the US, manufacturing output only returned to levels seen before the financial crisis in 2018. Household spending, which represents around 70% of the economy, has experienced more robust growth. But this has been achieved at the same time as consumers paying down debt, rather than borrowing to fund purchases. This does not feel like an overheating economy.

Trade remains the key risk. The signs we are seeing of a pick-up in global growth are still fragile. A significant setback in US China negotiations could extinguish them.

The world's economy continues to grow...

...but the origins of that growth are shifting

^{Source: Schroders, December 2019}

Central banks on standby

At its October meeting, the Federal Reserve signalled that it would probably leave interest rates at current levels for now. However, it has made clear that it will not be leaving the economy or markets to fend for themselves.

In a recent speech, for instance, Fed Chair Jerome Powell expressed concern that persistently low inflation could result in “unhealthy downward drift in inflation expectations”. The Fed’s expectation is to leave rates unchanged in 2020.

In Europe, meanwhile, Christine Lagarde has assumed the presidency of the European Central Bank. After her predecessor helped secure the stability of the eurozone following the region’s financial crisis, she will be hoping to finally lift the region out of its low growth malaise.

UK election update

The UK election in December 2019 gave a very strong result for the Conservative party. With a clear majority, they should be able to get their withdrawal agreement through Parliament, formally taking the UK out of the European Union.

It is also, at long last, a good result for the UK polling industry. The vote went the way the latest surveys predicted, even if they underestimated the size of the majority.

In the short-term sterling and domestic UK stocks rallied sharply. We will continue living with some uncertainty around the course of Brexit as the UK attempts to negotiate trade deals.

The prime minister may find that “getting Brexit done” is not as easy as his campaign promise suggested.