Over the past month, global equities consolidated 2019 gains. This was primarily driven by the fading of trade-related geopolitical risks, initial signs that growth in China is stabilising and central banks across the world turning more supportive of risk.
Overall, the MSCI All Country World index gained 3.1 per cent over the month to extend its year-to-date gains to 14.5 per cent. The rally was broad based with all major sub-indices closing in positive territory. The MSCI G7 index, the MSCI Emerging Market index and the MSCI Frontier Market index added monthly gains of 3.2 per cent, 3.1 per cent and 0.1 per cent, respectively.
Chinese equities continue to be at the forefront of this rally. The Shanghai Composite index gained 5.4 per cent to take its year-to-date gains to 31.2 per cent. The rally is indicative of growing confidence among investors that the stimulus provided by the Chinese government will support the economy and an anticipation that a trade deal with the US is within reach. Within the Mena region, the DFM index (up 6.5 per cent) and the Tadawul (up 6.2 per cent) saw renewed investor interest.
One surprising feature of the rally in 2019 so far has been the absence of volatility across markets. The VIX index (US) is currently at levels last seen in September 2018. Since the start of the year, the VIX index, the V2X index (Europe) and the VXEEM index (EM) have dropped 52 per cent, 53 per cent and 38 per cent, respectively.
The consensus among investors remains that we are in a late-cycle of growth, with the divergence of opinion seeming to be about the length that this late-cycle will extend. It is worth highlighting that equities tend to outperform during late cycles. According to a study by BlackRock Investment Institute, global equities have produced quarterly returns in these periods above the full-cycle averages in the past. This is based on returns in the 28 quarters that fell into "late-cycle" periods since 1988. The study also shows there is a wide dispersion around these average returns, particularly in emerging market equities.
The direction of equities over the next month could well be shaped by how the first quarter earnings season of 2019 pans out. The expectations are at multi-year lows and valuations at near-term highs. If earnings come in better than expected then it would provide a further fillip to the current momentum. The early indications paint a mixed picture. With nearly 15 per cent of S&P 500 companies having reported earnings, the blended first quarter earnings 0f 2019, according to FactSet, have dropped 3.9 per cent. This is relative to expectations of a 4.1 per cent decline at the end of first quarter. The MSCI World is currently trading at 16.2 times 2019 earnings relative to 10-year average price/earnings ratio of 14.3. The largest divergence between current multiples and historical averages is in US equities.
The general refrain is that as equity prices rise, the money flowing into the asset class grows. However, that has not been the case in the first quarter of 2019. According to data from EPFR, global equity funds had an outflow of 0.7 per cent of assets under management (AUM) in the first quarter of this year, which is the largest outflow since the second quarter of 2016. In terms of regional flows, there is a divergence between emerging market equities and developed market equities. EM equities saw an inflow of 1 per cent of AUM in the first quarter of 2019 compared to outflows from global, US and Europe dedicated funds. Within the developed market space, only Japanese equity funds saw inflows in the first quarter of 2019.
The flow data clearly suggests that investors broadly remain in "sell the rally" mode and hesitant to chase the sharp rebound in equities. The trend opens up the opportunity for equities to "melt-up" and rally further, however, should the current tailwinds gather further pace. The current earnings season could well be an important piece of the puzzle in attracting flows back to equity markets. A trade deal between the US and China in the next month or so could also be a very important catalyst. The positioning data from the Commodities Futures Trading Commission suggests that this possibility is gaining ground, as the S&P 500 pull/call ratio has dropped significantly from the highs at the start of the year.
Tim Fox is chief economist at Emirates NBD and Aditya Pugalia is a senior markets analyst at the bank