A New Risk-Off Phase After The Fed Meeting

A dovish Fed rate hike?
Investors were expecting the Federal Reserve (Fed) to make a rate hike plus a change in guidance on Wednesday. Without surprise, policy makers decided to go ahead with a rate hike. To the satisfaction of observers, they also downgraded the number of expected rate hikes in 2019 from three to two. Concerning their forward guidance, however, the change was marginal: the word “some” was added to “further gradual increases in the target range of the federal funds rate”. What unnerved investors was that during the press conference the Fed described the process of balance sheet normalisation as being on “autopilot”. The 10-year Treasury yield reacted immediately by falling from 2.83% to 2.75% and the S&P 500 index wiped out Wednesday’s modest morning gains to close the day down 1.5%. The Topix lost 2.5%, the MSCI Emerging Market 0.9% and the Euro Stoxx opened 1.8% lower. The trade-weighted dollar rose initially but then lost ground during Thursday morning’s trading session. The oil price did not escape the rise in risk aversion. The Brent oil price fell below USD 56.

Global growth fears intensify
The Federal Reserve has thus added another layer to existing growth fears. Other recent worries were sparked by the European Central Bank—which downgraded its outlook for growth and inflation and stated that “risks are moving to the downside” and the further deteriorations in PMI indices. Let’s not forget the weaker data in China where retail sales have reached their lowest growth rate since May 2003 and industrial production has come out below expectations.

Too early to fear a recession
2018 marks the year in which global growth has reached its highest level since 2011. In this environment, companies have generated a 16% growth in earnings. Looking ahead to 2019, we expect a) good consumption trends, backed by rising wages and steady job creation; b) appetite for investing in projects and equipment, particularly in digital transformation; c) countries such as Japan and China to implement fiscal measures for supporting growth and d) only a moderate decline in global trade. Overall, we do not anticipate a recession. Rather we expect global economic activity to be moderate, which would allow companies to continue to deliver earnings growth.

Lack of catalysts in the short term versus a positive medium-term outlook
In the coming months, economic data are likely to confirm that 2018 was indeed the year of peak growth and investors will remain wary of the extent of the slowdown. At some stage though, they will come to the conclusion that recession fears are exaggerated, which will lay the foundations for an upward trend in risky assets. In the meantime, volatility will remain elevated.

Encouraging signs from sentiment and technical indicators
Four indicators have recently sent encouraging signals to the markets. The first one is the gap between bulls and bears in the American Association of Individual Investors survey, namely a gap of 28 percentage points in favour of the bears. The last time this happened was in early January 2016, when a new bullish phase was just emerging. The second indicator is the State Street Investor Confidence index, which has declined to historical lows, in line with early 2009 levels, when the current bull market began, or with levels reached at the end of 2012 following the famous words of Mario Draghi about the ECB “doing whatever is necessary”, which preceded a nice uptrend in equities. The third indicator is the number of stocks cruising above their 200-day moving average, which is now at around levels that usually correspond to good entry points in equity markets. The same observation can be made about the fourth indicator: the ratio of new highs versus new lows.