Chief economist update: Equity market rally has legs

Equity markets everywhere may not be climbing in a straight line, but they are climbing. This is happening against a backdrop of continued global economic and financial uncertainties.

In its 'World Economic Outlook, April 2019' report - where it downgraded its 2019 world economic growth forecast to 3.3% (from 3.5% in its January 2019 outlook and 3.7% in October 2018) - the IMF enumerated these downside risks.

"Tensions in trade policy could flare up again and play out in other areas (such as the auto industry), with large disruptions to global supply chains. Growth in systemic economies such as the euro area and China may surprise on the downside, and the risks surrounding Brexit remain heightened. A deterioration in market sentiment could rapidly tighten financing conditions in an environment of large private and public sector debt in many countries, including sovereign-bank doom loop risks," it said.

Yet, equity markets appear to remain unperturbed. The CBOE VIX index - the "fear gauge" - has dropped back down to October 2018 lows. It currently stands at 12.32 - 59% down from the 2018 high of 30.11 recorded four days before Christmas of the same year.

Both developed and emerging equity markets have completely erased their 2018 three and half months into 2019. The MSCI world index has rallied by 11.9% this year to date, more than offsetting last year's 9.1% decline. Similarly, the MSCI emerging market index is up 9.1%, reversing the 7.5% loss recorded in 2018.

The sixty-four million dollar question is does the equity rally have legs? Will global equities continue to march higher through to end-2019?

In a way, I've already answered this question on this space last month, arguing: "It'll be so perfectly rational to extrapolate growth in the global economy ... if everything remains the same."

But they don't. Fiscal and monetary authorities react. The experience of the GFC just a decade before is a perfect example.

The same thing is happening now as I write. The Fed's on pause; the ECB has just announced LTRO III; the BOJ governor has said "we'll consider easing policy"; the BOE adding "gradual pace and to a limited extent" to its forward guidance that "an ongoing tightening of monetary policy over the forecast period ...  would be appropriate" etcetera.

The BOC has also changed its tune to "continues to warrant a policy interest rate that is below its neutral range"; and the RBA? Yes, it's now saying that "the next-move-is-up scenarios were more likely than the next-move-is-down scenarios" ... with financial market expectations for not only one, but two interest rate cuts gaining advocates as the year progresses.

And then there's China, which is easing both monetary and fiscal policies.

This is, more or less, what the IMF foresees: "While 2019 started out on a weak footing, a pickup is expected in the second half of the year. This pickup is supported by significant policy accommodation by major economies ..."

This is substantiated by the recent rebound in the global composite and services PMI indices and the slowdown in the rate of decline in the global manufacturing PMI.

Then again, the Fed could use the improvement in global economic activity as reason for resuming its policy normalisation path before 2019 is over.

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