Global equities: short-term caution versus medium-term optimism
On March 9, equities celebrated their 8th year of bull market. It had become the second longest in history. Longevity is however no cause for concern.
We still do not see an end to this bull market with an economic background that shows none of the excesses that usually warn of a coming downturn. The length of the current economic upswing is also the third longest, since 1850, based on data about the US economy. It would become the longest if it lasts until June 2019, which is good keeping in mind. For the foreseeable future, we expect positive trends in the global economy, allowing us remaining fundamentally positive on equities. In the short term however, we have several reasons for being cautious.
Neutral stance on the short-term outlook (3 months): time has come for selective profit taking
At the beginning of March, we turned neutral on equities for both fundamental and technical reasons. We added also the likelihood that investors would get increasingly concerned on a range of political risks. On the fundamental side, they were the following. First, the harvest of good macro news could hardly become better after positive economic surprises reached heights rarely seen in the past, calling for mean reversion of economic surprises. Second, there were early signs that leading indicators will see deterioration in their rate of progression. Third, the gap between the 10-year and two-year Treasury bond yields meant that volatility should rise going forward, which should not surprise at this advanced stage of the bull market. On the technical side, warning signs came from overbought conditions, complacency, or insider selling being at its highest in six years; now we can add negative divergences. Some profit taking is therefore warranted in our view, particularly on assets that are expensive, such as US small caps, or defensive in nature (but not healthcare and telecom operators), which are not those we favour for the medium term.
Given that the background is fundamentally positive, we believe that risks of sizeable corrections (larger than 10%) are limited. There are too many investors who feel they have not yet participated seriously to the current bull market. They will want to take advantage of any setbacks to raise their equity exposure as “hard” data progressively confirm “soft” data. Overall then, we essentially expect a period of rising volatility, which will allow fundamentals to catch up with investor hopes and cleaning the technical picture.