Investors have profited in 2019 as what I call the single-issue phenomenon continues to dominate capital markets — that is, focusing on a single item that provides short-term optimism but is unable to decisively reduce longer-term uncertainty. The question is how long this situation can last.
Repeating the experience of 2017, bonds and stocks both extended their rallies this year.
The returns were enjoyed widely by investors, not just the most sophisticated who have access to the harder to reach investment opportunities.
Gains were particularly pronounced for conventional investing approaches, due to high returns on the most widely held stocks, combined with an almost complete lack of disruptive financial volatility. The MSCI World stock index is up 24 per cent over the year so far. When it comes to traditional risk mitigation through buying government bonds, 2019 offered the ability to make money there, too.
This remarkable outcome has materialised despite visible problems. The global economy struggled for much of the year, putting a damper on business investment. A growing number of people took to the streets in both advanced and developing countries to protest economic marginalisation and social injustice.
The political move away from the centre continued, expanding the range of possible outcomes for the economy and the financial sector. Some of the most sophisticated segments of the financial markets, such as wholesale funding — the repo market — suffered bouts of instability and threatened malfunction.
And central banks were forced to abandon hopes of normalising monetary policies and to restart their bond-buying programmes, to reduce interest rates even further and to signal that ultra-low rates would remain in place for longer.
Despite their prior multiyear period of significant outperformance that saw valuations notably decouple from European and emerging market counterparts, US markets again delivered eye-popping performance in both absolute and relative terms, with the S&P 500 equity index up 27 per cent since January.
For the first part of the year, the single issue markets focused on central bank liquidity. A U-turn in Fed policy lubricated markets, offsetting concerns about the global economy.
This opened the way for what by some measures is the most accommodative global central banking policy stance since the global financial crisis. It also comforted investors in believing that central banks remain their BFFs — that is, "best friends forever".
For 2020 to resemble 2019 in terms of generous returns and low volatility, investors need to see progress beyond these short-term wins
But as the year proceeded, it became clearer to more people that protracted over-reliance on central banks was fuelling an ever-deepening set of unintended consequences and collateral damage.
Rather than lose the anchor of a supportive single issue, markets switched to focus on a new one: de-escalating trade tensions. Like central bank support, the beneficial effect was subject to occasional doubt. But the overall market influence remained positive, and investors' bets again proved correct.
Over the weekend, China and the US confirmed that they had reached a "phase one deal" that removes the imminent threat of trade escalation and also boosts the hopes of some for a subsequent, more comprehensive and durable resolution of the trade conflict. A headwind to global growth thus stands a better chance of lifting.
This would stimulate higher business investment in trade-orientated sectors and reinforce the growth impulse from still-healthy domestic segments. With that, improved fundamentals would be better placed to validate elevated asset prices and push them higher in a sustainable fashion.
As much as we should hope for such an outcome, the realities on the ground call for caution over the medium term. Economic tools such as tariffshave been weaponised in a manner that is unlikely to be reversed anytime soon, especially as the underlying drivers are no longer limited to economics but also include national security issues.
There is unusual broad-based bipartisan support in the US for a continued tougher stance vis-à-vis China — with the refrain being "if not now, when?" Also, the mini trade deal does not really address the longstanding issues related to unfair trade practices.
For 2020 to resemble 2019 in terms of generous returns and low volatility, investors need to see progress beyond these short-term wins. That means the creation of political conditions that allow for the sustainable implementation of the comprehensive pro-growth policy approach that investors are seeking.
Without that, the constructive short-term outlook will face a bumpy transition over the medium term. The remarkable rally will curiously remain one of the most unloved in investing history, keeping considerable investment funds on the sideline.
And the more volatile realities — be they economic, financial, institutional, political or social — could prove harder to keep at bay.
- The writer is Allianz's chief economic adviser and president-elect of Queens' College, University of Cambridge.
Written by: Mohamed El-Erian
© Financial Times