As 2019 has trundled on, global equities have rallied a phenomenal 19% year to date, taking several indices into record territory. Investors have understandably questioned whether these phenomenal returns can continue.
This debate intensified in August, when a flurry of trade-related tweets from Trump, and declining macro data, sent global bond yields tumbling. The spread on 2-year/10-year Treasury yields was pushed into negative territory for the first time since the Global Financial Crisis.
However, a softening in rhetoric more recently, and continuing improvements in economic data (including the German economy narrowly avoiding a technical recession last week), has buoyed investor confidence, sending stocks higher once more.
This rise has been accompanied by a steep fall in the Fed’s probability of recession index earlier this month. Fed Chair Jerome Powell also reiterated his conviction in the strength of the US economy on Thursday at the House Budget Committee.
Signs of Investor Optimism
The increased optimism can be most clearly seen in the bond market, where the Treasury curve has steepened significantly over the last few weeks, with yields tumbling in the short end of the curve and rising slightly in the longer end. This bull steepening has firmly pulled the curve out of inversion territory, with the Treasury spread currently sitting at +21bps, the widest it has been since July.
We expect that if the situation continues to improve, it may benefit risk assets. This view is further supported by the elevated cash levels investment managers currently sit on. Moreover, the FOMO (fear of missing out) associated with managers who have missed out on the previous risk rallies could give equities a final boost coming into the end of the year.
Positioning for Potential Headwinds
An obvious danger to positioning for an equity uptick is the risk of a trade tweet derailing the current rally. Investors may wish to mitigate this risk by positioning themselves in more domestically focused areas of the market, such as mid-cap or small-cap exposures.