Voya Multi-Asset Perspectives - A Strong Equity Rally, Then a Wobble

Paul Zemsky

Paul Zemsky, CFA

Chief Investment Officer, Multi-Asset Strategies and Solutions

Barbara Reinhard

Barbara Reinhard, CFA

Head of Asset Allocation

February proved to be another solid month of gains for global equities following on the strength in January. The continuation of the recovery in risk assets has been most evident among U.S. small- and mid-cap equities, then among U.S. large caps; followed by shallower gains in international developed and emerging markets. In fixed income markets, credit remained the top performer with high yield and leveraged loans outpacing U.S. Treasurys.

In our view, the bulk of the rally has been driven by the severely oversold conditions that presented themselves at the end of December. A couple of key factors have lifted investor sentiment; most notably, the U.S. Federal Reserve’s pivot in January to data dependency with its interest-rate path has shifted market expectations from a hiking cycle on pause to signaling a neutral stance. Additionally, uncertainty surrounding China–U.S. trade tensions has diminished, at least over the near term.

Against this backdrop, small company stocks, as measured by the Russell 2000 index, returned 5.2% on the month. The S&P 500 gained 3.2%, with strong boosts from the information technology and industrial sectors. The MSCI EAFE and Emerging Markets indexes gained 2.6% and 0.2%, respectively.

Since early March, after the disappointing February jobs report pointed to a slowing of U.S. employment growth, markets have been relatively weaker. We don’t think this is a continuation of the weakness of late last year, we see it as more of a consolidation in which markets can build a more solid base.

Tactical Indicators

Tactical Indicators

Figure 1. Since the 1950s, recessions haven’t resulted unless the term structure slope moves closer to zero or lower

Figure 1. Since the 1950s, recessions haven’t resulted unless the term structure slope moves closer to zero or lower

Source: Bloomberg and Voya Investment Management, data as of 3/1/2019

Figure 2. Earnings estimates for global markets may be stabilizing

MSCI ACWI Earnings Estimate Revision Ratio
Figure 2. Earnings estimates for global markets may be stabilizing

Source: Bloomberg and Voya Investment Management, data as of 2/28/2019.

Figure 3. The AAII Bull/Bear ratio is trending toward overbought

Figure 3. The AAII Bull/Bear ratio is trending toward overbought

Source: Bloomberg and Voya Investment Management, data as of 2/28/2019.

Portfolio Positioning

Portfolio Positioning

Investment Outlook

We know from history that sentiment driven rallies can be quite powerful, especially when starting at oversold readings. The question asset allocators need to ask themselves from here is: are there enough supports to sustain the recent gains?

Let’s answer that by starting with the fundamentals. Most of the concerns surrounding risk markets in 4Q18 were directly related to the unfolding global growth scare. On that front, the latest purchasing managers’ surveys, which we watch closely, confirm the global economy is in a sustained slowdown, with few signs of near-term upside potential. Overseas demand continues to present a downside risk as export orders have contracted for a sixth straight month.

However, the new development we find interesting is that for the first time since April 2013, the emerging markets reported a higher PMI than developed markets. With an eye toward global earnings, it is worth noting the global earnings revision ratio was nearly unchanged in February (Figure 2); to us that is important after the ratio suffered a steep fall in 2018. It may be the earliest sign of stabilizing, comparable to what we witnessed in the equity market pullbacks of 2011 and 2015, which were of similar magnitude to the one we just experienced.

In addition to the data, communications from global central banks have taken a sharp turn toward dovishness and patience on moving any further to tighten monetary policy. The Fed made that clear to financial markets in early January, and the European Central Bank did so in early March. In our view, the markets need to see evidence of green shoots in a broader set of data to continue to foster gains in risk assets.

As of early March, it looks like markets are undergoing their first pull-back of the year, with equities down approximately 2–4% across various indexes. We believe this is more of a wobble than a resumption of the 4Q18 decline — in part because valuations are not as extreme as they were in 2018, and in part because we may be seeing a buyers’ strike since equities have been rallying over the past two months.

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