It is always darkest before dawn, an expression that can in retrospect describe the conclusion of last year and the beginning of 2019. During the late autumn and, to a greater extent, all the way into the Christmas holiday, the financial markets were dominated by a strongly negative sentiment, with economic worries exacerbated by a continued belief in monetary policy tightening. The preferred interpretation was clearly negative, and 2018 closed on a low note. With the first quarter now over, we can instead look back on an absolutely fantastic start to the year, with almost all the worries blown away – at least when it comes to stock market performance.
I wrote last summer about a thunderstorm moving in over my tranquil holiday resort, with lingering memories of parasols flying in the sudden storm winds and the rain coming over to abruptly replace the hot summer weather. The first quarter of the year has been the opposite experience, with euphoria breaking out based on really only one thing: the US central bank. We have seen quite a few indicators of a slowdown in the real economy during the quarter, in both Europe and China, and many companies have reported weaknesses. This is affecting both car manufacturers and banks, whose results or outlooks are clearly worse than expected. Likewise, the central bank and a number of other institutions have reduced their forecasts for this year. Long-term interest rates, which, despite the influence of central bank action, still reflect some kind of future expectation, are now pricing in extremely levels well into the future. Again.
We have been living in this environment for many years now. At first surprised and doubtful, then increasingly accepting, before finally, somewhat resignedly, admitting that this is probably the new normal. The Japanese 10-year bond yield is now negative and the Swedish yield is 0.2 percent, which is close to record lows. In all "normal" cases this would indicate extreme misgivings about both economic growth and rising inflation. If it does not indicate recession, then at a minimum it indicates really weak growth.
But despite this, the stock market is strong. The reason, of course, is the discounting effect. With low interest rates from central banks, the economy is further stimulated. The announced cuts in central bank balance sheets are now expected to return to the status quo, and both the economy and investors themselves expect to continue to be supported by a very stimulatory monetary policy for the foreseeable future. All investments that generate a better return than the extremely low risk-free interest rate will be attractive. Investments in companies that can both create a real value increase and at the same time offer a dividend yield in excess of the risk-free option become very attractive. What we can note is that the upturn so far this year has at least partly been driven by more defensive investments, in companies that are expected to generate growth even in a weaker economic climate.
As so many times in the past, a seasoned equity manager can observe that expectations, at least in the short term, mean so much more than corporate profit growth. The opposite is true in the long term, when the profit trend is more or less entirely responsible for the development of a share price. But with seemingly very great whimsy, the market sometimes chooses to look extremely pessimistically at the future, before moments later applying a completely different approach without actually producing much in the way of new facts.
We can note that the issue of Brexit was still not resolved in the first quarter. On the contrary, it is just as uncertain as last autumn. The trade discussions between the US and China are still ongoing and the deadline has been postponed, but there has really not been much new information. At the margin, the old dialogue between the US and North Korea, which completely controlled the market for a while, has taken a substantial step back and again feels very uncertain. All this while multiple signals of a weaker economy have been delivered from companies and institutions.
As the spring sunshine now breaks through over Stockholm in late March, it feels like the market is very outstretched. If it was too gloomy in December it now feels undeniably like the market is taking the liberty of euphorically pricing in a new Goldilocks period, with the economy still strongly stimulated by the central banks but never getting weak enough to really affect the profit trend.
As so many times before, I would encourage a little sense. After one of the strongest starts to a stock market year in a very long time, it may be wise to remove a few chips from the table. Right now, the spring sun is shining but there has been snow in April many times before.
We thank you for your trust.