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

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.

However, with more investors now expecting a rate cut rather than a rate hike in 2019, shifting expectations may push equities in the other direction if the Fed decides economic data warrants another hike – something that looks possible in the later part of the year.

Global growth has slowed. Manufacturing activity and trade data signal a weaker global growth environment. Survey-based measures of growth have been pointing downwards for several months and growth fears certainly played into the December slide. But, as investors adjust to weaker growth expectations, slower growth barring a recession is not an insurmountable hurdle for markets.

However, as this picture feeds into earnings outlooks, markets may face a tougher climb. Forward guidance suggests a weak earnings outlook for 2019. The US’ fourth quarter last year was not bad overall, but the message from most companies was to expect a challenging 2019. A high US dollar hurts international sales, and rising wages and input costs and higher borrowing costs could all crimp margins.

Investors treated the news of the US postponing its next round of tariffs on Chinese imports as confirmation that trade tensions would be defused and that they could cross the trade war off their list of worries. In this case, forward-looking investors may have got too far ahead of themselves. While policymakers have a lot of political incentives to reach a deal soon, the US and China remain far apart on key issues. While a resolution this year is likely, investors should expect many more headlines about this.

Political hurdles will be cleared, as policymakers try and tamp down trade tensions ahead of the 2020 elections. While economic data is softening, most major economies seem to be gliding towards a lower rate of growth rather than stalling. But markets will price these risks in different ways at different times across different assets. For equities, that means a volatile year ahead. Whether we end the year above or below current levels will depend on how far past their current worries investors can look.

Hannah Anderson is a global market strategist at JP Morgan Asset Management