Equity markets look more attractive

In last month’s Market Perspectives we argued that a period of consolidation was likely given limited room for positive surprises. The month of May offered very little optimism. The news flow was negative, with trade tensions turning into an outright trade and technology war and macroeconomic data failing to reassure. Yet, global and US equities are down less than 7% from their peak in late April.

Downside protection

We attribute the market’s resilience in May to hopes that someone will step up to prevent sentiment deteriorating further. The three favourite “puts” (insurance against downside moves) are:

• The “Trump put” entails the US president adopting a more accommodating tone with regards to trade negotiations;
• The “Xi put” relies on Chinese authorities supporting their economy (and domestic markets) by way of stimulus injection; and
• The “Powell put” factors in a dovish US Federal Reserve (Fed) in response to either a significant drop in equity markets and/or a marked slowdown in the US economy.

We believe that the Trump put is key to supporting market valuations in the short term. Indeed, President Xi does not face re-election next year and has time on his side. He could potentially tolerate a higher degree of volatility than the US president.

Similarly, any action from the Federal Open Market Committee (FOMC), chaired by Jerome Powell, may be some time off. The FOMC’s policy pivot witnessed in December occurred only after US markets plummeted almost 20%. In addition, the market is already pricing a dovish Fed with the probability of a rate cut in December standing at around 75%.

Progress in US-China trade talks critical

While we would not question Trump’s desire to see US equity markets perform well, we believe that, without real progress in the trade talks, the market may soon start questioning the viability of this put. In this sense, the G20 summit on June 28-29 will be crucial. The bar is low for positive surprises and simply avoiding incremental tariffs while releasing some pressure on Chinese technology companies, may be enough to trigger a market rally.

In this context, we remain of the view that, in the short term, US equities will consolidate further in a range between 2,700 and 2,900 with spikes of volatility. Below 2,800 we believe that the risk/reward profile becomes more attractive but see limited upside absent any progress on the trade front.

With increasing political uncertainty in Europe, we maintain our preference for US and emerging markets. The latter in particular appears attractive to us within the context of a 9% pull back since the high of mid-April. In this fast changing environment, active management remains essential in our opinion.

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