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A synchronized recovery in the world economy is making investors more optimistic, says Lukas Daalder.
The Dow Jones Industrial Average managed to set 12 consecutive record highs in February, while the positive sentiment accruing from consistently strong economic data shows no signs of abating. However, a heavy upcoming political agenda, and the continuing unease over the wild rhetoric of new US President Donald Trump means Robeco remains neutral on equities for now.
“Underlying data has continued to be predominantly positive across the regions of the world, with especially Europe surprising on the upside,” says Daalder, Chief Investment Officer of Robeco Investment Solutions. “Consumer spending is on the rise almost everywhere, while both producer and consumer confidence indicators are at levels we haven’t seen for quite some time.”
It is no surprise that risky assets are doing fine
“We are in a synchronized economic recovery, so it is no surprise that risky assets are doing fine. The last time we experienced a broad-based positive momentum of this magnitude was in 2009, when the world economy was finally rebounding after the deep recession.”
“With such an acceleration of growth momentum, stock markets are more than willing to accept anything that is thrown at them, such as the uncertainty surrounding the European elections, Trump’s latest plans (and tweets), or the rising headwinds for globalization. None of this seems to be able to dent the positive sentiment currently seen in the riskier parts of the financial markets.”
Even Trump has helped things along after striking a more conciliatory tone in a speech to the US Congress. “All of a sudden he embraced NATO; he refrained from mentioning fake news; and he even seemed eager to bridge the gap between him and his opponents. A sigh of relief followed, with stocks rallying as ‘tensions’ declined,” Daalder says.
“There is only one thing wrong with this storyline: namely that there was never any build-up of tension in stocks to begin with; volatility has been near absent, with stocks trading in very narrow trading ranges for most of the time.”
“So, if stocks don’t decline on rising risks, but do rally when those risks appear to have declined somewhat, the conclusion is pretty simple: stocks want to go higher, and will look for reasons to do so. Sure, there are all sorts of nasty scenarios possible, but until they actually materialize, the stock market appears to be more than willing to ignore them for now.”
Those ‘nasty scenarios’ cannot be overlooked, Daalder says. “There is another side to this as well though: whereas stock markets can choose to ignore the latest wild statement by Trump, it is clear that corporate investment decisions are made on more solid considerations.”
“There are still a number of uncertainties hanging over the market which can be of crucial importance for any investment decisions. In the US, these include the tariffs and other threats by Trump. And in Europe we face potentially more populist revolts in elections in the Netherlands, France and Germany, along with the UK triggering Article 50 to begin the Brexit process.”
The room for upward surprises has clearly diminished
Daalder also believes that the economic data that has fueled the equities rally may be close to an inflection point. Purchasing Managers Index (PMI) readings have so far consistently been above 50, the level which indicates expansion. Much of the rally has been based on data coming in higher than the ‘consensus’ of economists and market analysts had predicted, a trend that is measured by the Citi surprise index.
“The room for upward surprises has clearly diminished,” Daalder says. “As a rule, the Citi surprise index is mean reverting, and with the index consistently above 50, and the Eurozone firmly above 70, that poses the risk that tailwinds will start to turn into headwinds. Will the current macroeconomic strength have enough momentum to carry stocks higher, even if data does not surprise anymore?”
“And do you really start investing with all these issues unclear and unresolved, or would you like to get a bit more beef on the bone? Some might invest, but in general this does not look like a textbook example of an investment boom environment. More clarity is needed for that. That makes us neutral on stocks for now.”