Few would have predicted at the end of last year, when stock markets were in free fall , that global equities would bounce back so spectacularly. In the first half of 2019, the MSCI All-Country World Index, a leading gauge of shares in developed and developing economies, surged almost 15 per cent, its best first half since 1997. The fierce rally has left the index just 4.5 per cent shy of its all-time high reached in January last year. The dramatic gains in stock prices stem mainly from the outbreak of dovishnesss among the world’s leading central banks, led by the Federal Reserve, which unexpectedly put its interest rate-hiking campaign on hold in January, and is now widely expected to begin cutting rates as an insurance policy to help sustain America’s economic expansion. What is more, the rally in equities is broad-based, unlike the previous gains in 2017 and parts of 2018, which were led by the US. Europe’s main stock index, the Stoxx Europe 600, shot up nearly 14 per cent in the first half of this year, buoyed by signals from the European Central Bank that it will relaunch its quantitative easing programme if the threat of deflation in the euro zone becomes more severe. In a sign of the extent to which expectations of further monetary loosening are turbocharging this year’s rally, the yield on the two-year bond of Italy – one of the world’s most heavily indebted countries whose populist government is deeply hostile towards European integration – briefly fell into negative territory earlier this month for the first time since May 2018. As JPMorgan rightly noted in a report published on Friday, the recent moves in markets “owe entirely to hopes of global policy stimulus”, the driving force behind almost all the other major rallies over the past decade. Yet the policy responses and reassurances provided by the main central banks have lost a lot of their potency over the past few years as central banks themselves have become sources of market volatility, and global growth has again slowed sharply, particularly in the case of Europe. Era of cheap loans to return as central banks set to cut rates Just a cursory look at the June edition of Bank of America Merrill Lynch’s fund manager survey shows the extent to which investors are sceptical about the effectiveness of monetary policy. Respondents to the survey were not only the most bearish about the outlook for the global economy since the 2008 financial crisis, they reduced their allocation to stocks to the lowest level since 2009, and upped their exposure to bonds to the highest level since 2011. What is more remarkable, however, is that while investors are piling into assets that benefit from lower rates, such as bonds, cash and utilities, they are shunning investments that profit from stronger growth and inflation. Cyclical stocks, such as industrial companies and energy firms, and small-cap shares – both of which tend to enjoy strong gains when growth is recovering – are underperforming. To put it another way, while investors are betting that central banks will ease policy, they do not believe that further loosening will prove effective. If investors themselves have little confidence in the key factor propelling equities higher, then it is only a matter of time before markets begin to buckle. Indeed, it is surprising that the rally has lasted this long. Not only are stocks surging for the wrong reasons – expectations of more stimulus, which not only is now deemed to be ineffective but is likely to prove counterproductive given that rates are already at historically low levels – there is practically no upside risk and plenty of downside risk. Nicholas Spiro is a partner at Lauressa Advisory