Macroscope | Which way now – have we reached a ceiling for equity prices this year, or is there more to come?

Expectations of risks are often more important than the risks themselves. Investors should remember that, in reality, the US-China trade war is far from over, and the Fed’s softer policy on rates may change later this year

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White House economic adviser Larry Kudlow discusses the US’ trade negotiations with China on January 22. Photo: Abaca Press/TNS

Published: 11:28am, 15 Mar 2019Updated: 10:31pm, 15 Mar 2019

Over the past three months, equity markets have given investors plenty to get excited about and plenty more to worry about. The dive most equity markets took last December set up a big rally in the first weeks of the year. The first week of March gave many investors déjà vu when major markets all fell by over 1 per cent within the week. Corporate bond spreads widened and safe-haven assets, like gold, rallied. Then markets reversed again with a strong week in risk assets.

Yet, looking over a slightly longer time horizon, most markets have just managed to regain their September 2018 highs. This begs the question of what pushed markets higher this year and how sustainable future price increases are. In other words, are current equity prices a ceiling or a floor for 2019?

First, it is important to calibrate expectations properly. The US is in the later stages of its business cycle, which historically has been an environment of both modest, positive global equity returns and high volatility. Therefore, a volatile year with modest returns should not be a surprising outcome. Investors will contend with slowing economic momentum, continued political drama from Brexit and upcoming elections throughout Asia, and should not dismiss trade as a worry.

Markets are forward-looking by nature, which means price moves often reflect changing expectations rather than an actual new development. Most of us aren’t particularly comfortable unless we have something to worry about – so once one risk is off the immediate horizon, we naturally look for the next potential “what could go wrong” scenario. Expectations of risks are often more important than the risks themselves. So what’s changed this year?

Most importantly, investor expectations for policy, particularly central bank policy, have shifted. A more patient Federal Reserve, as signalled by its comments in January, cheered markets. An easier Fed means more liquidity and support for risk assets. The Fed taking a pause while it waits for new data is not a new approach, but its willingness to pause all policy operations, especially balance sheet reduction, reassured investors they could count on liquidity to remain ample.