After a strong beginning to the year from equities, we have recently seen more uncertainty creep into markets. This raises the question as to whether there will soon be a reversal of market fortunes. Some of the issues that plagued markets last year are beginning to resurface, including a potential hard Brexit and the absence of an agreement between the US and China on trade.
Still, more accommodative monetary policy, reflected in the recent tilts by the European Central Bank (ECB) and the Federal Reserve (Fed), has underpinned a strong rally in bond markets, which has also supported equities. More important over time, however, is whether the weakening of global growth last year will continue, or whether some re-acceleration in the second half of 2019 will take place.
We endorse the latter view. China is easing policy, and much of the European slowdown was due to one off factors. The avoidance of hard Brexit or tariff escalation will help restore confidence. All of those factors should underpin risk assets this year, even as they undermine the recent strength of government bond markets. The key issue for investors, in other words, is whether the political and policy uncertainty that undermined confidence in late 2018 can be avoided during the remainder of 2019.
To be sure, even if growth stabilises and then re-accelerates, the scope for equity market gains is limited, particularly after the strong gains in the first three months of 2019. Margins and capital efficiency have peaked in the US. In Europe and emerging markets, the potential for stronger earnings is there, but investors are unlikely to anticipate it without some acceleration of top-line growth. Cyclically sensitive sectors such as European financials or consumer discretionary are likely to remain handicapped by lack of conviction in the growth rebound.
Accordingly, we continue to prefer allocations to quality and minimum volatility as equity factors. Value is only likely to recover if growth surprises turn more convincingly positive and yield curves steepen. Momentum will struggle if overall market performance remains uneven, characterised by rapid rotation. Lastly, we continue to believe that as bond yields rise from here, achieving diversification requires allocations to liquid alternatives, including target return and alternative risk premium strategies.