For global investors, the sun has been shining for the last two months. Stock indices have gained between 1% and 8%, with developed markets rising the most, and many equity markets are closing in on all-time highs.
Sovereign bond yields are up by 10 to 40 basis points, the highest for long-dated bonds, indicating that investors are back in risk-on mode. Prices of safe-haven commodities such as gold have seen some declines, while prices of oil and industrial metals such as copper have seen some small rises.
Backing the recent risk-on sentiment are three factors: (1) economic data, which, though relatively weak, is beginning to show signs of stabilisation; (2) liquidity injections into the world economy by central banks; and (3) global risk events showing signs of abating, at least for now.
As for economic data at the aggregate level, global manufacturing (as measured by purchasing managers' indices in various economies), while still in negative territory, shows signs of stabilising after two years of contraction. In contrast, the service sector, though in expansion territory, has been deteriorating a bit.
For economic data at the country-specific level, signs are mixed, though some encouraging indicators are being seen. This is evident on two fronts in the US: the real estate sector and financial conditions. This reflects the fact that the recent Fed rate cuts have helped reduce financial costs for homeowners, which has spurred higher real estate activity.
Signs on other economic fronts, such as consumption, investment and industrial production, are not as encouraging. This is because the negative effect of the recent slowdown has been heaviest on international trade and manufacturing.
In Europe, recent economic data such as third-quarter GDP growth suggests that a recession has been averted, both at the aggregate level and the country-specific level. The euro zone as a whole, as well as major members such as Germany, Spain, France, Italy and the Netherlands, has seen economic growth in positive territory, albeit at stall speed.
The euro-zone economy faces several challenges, both structural -- an ageing society and the north-south divide -- and cyclical -- the recent downswing in manufacturing and the unwillingness of conservative politicians (notably in Germany) to use fiscal firepower to boost their economies.
In China, recent economic data is not very encouraging. Industrial production and export-import numbers are deteriorating sharply, while slowdowns in domestic consumption and the service sector are milder.
The recent move by the Chinese central bank to relax its monetary policy by cutting financial costs via the reverse repo and a new benchmark policy rate (prime lending rate) is an indication that the government is trying to avert a sharp economic slowdown. This comes despite the fact that the economy is facing mild "stagflation" (an economic slowdown but higher inflation due to higher pork prices because of African swine flu). This curbs the central bank's ability to provide stimulus.
The global economic slowdown has led to a change in monetary policy for major economies. Central banks around the globe have cut interest rates and expanded money supply, while major central banks have restarted their bond-buying programmes. In the US, reduced interest rates and the lowering of long-dated bond yields have lessened mortgage rates, which helps lower the financial cost of home ownership and boosts activity in the real estate sector.
But most of all, it is liquidity injection, known as quantitative easing (QE), that matters to the financial market. In our view, the rally in global markets is mainly due to liquidity pumped in by global central banks.
A recent SCB Securities study found that since 2013, the increase in balance sheet assets held by four major central banks (the US, Europe, Japan and Britain) was positively correlated with the rise in global stock indices, especially in the US. The recent increase in assets held by central banks (US$322 billion in the year to November) coincided with the rise in stock markets around the world.
Most of the fears regarding the global economy in September stemmed from the real possibility that the global trade war would intensify. In the past month, the risk seemed to be abating somewhat, with a limited phase-one trade deal between the US and China believed to be in the final stages of negotiation.
In Britain, the chance of a disruptive no-deal Brexit has dropped sharply with the replacement of the Northern Ireland "backstop" with a more flexible arrangement. But no Brexit at all is still possible, depending on the outcome of the Dec 12 election. If Boris Johnson's Conservatives, now leading in the polls, fail to win a majority to push Brexit across the finish line, all bets are off.
With these three factors still in play -- at least for now -- we believe that risk-on sentiment will continue at least into the beginning of next year. This is based on the assumption that event risks do not escalate sharply, the global economic backdrop does not deteriorate markedly and liquidity injections continue, at least through the first quarter of 2020.
Consequently, we recommend that investors start to accumulate risk assets such as stocks in developed markets and in emerging markets such as China, while underweighting fixed-income assets such as treasuries, investment-grade debentures and REITs.
We believe that the recent rebound in financial market performance will prove to be short-lived and is sensitive to any downswing in the global economy. On this basis, we recommend that investors diversify their portfolios in order to limit losses in case any of the factors noted above unexpectedly and suddenly turn sour.
Piyasak Manason is senior vice-president and head of the wealth research department at SCB Securities. Email piyasak.manason@scb.co.th
