Downbeat economic and political headlines contributed to a more subdued tone to equity markets on Thursday morning. US Trade Representative Robert Lighthizer said on Wednesday that “much needs to be done before an agreement is reached” with China. The summit between US President Donald Trump and North Korean leader Kim Jong-un ended with no agreement. And China’s manufacturing PMI for February came in at 49.2, in contractionary territory for the third month in a row and at the lowest level since February 2016.
S&P 500 futures pointed to a 0.3% lower start to the day. But we still see factors that are likely to support this year's equity rally:
* Further fiscal policy stimulus in China is likely. China's National People's Congress will commence on 5 March. We expect cuts to corporate tax, VAT, and fees, as well as subsidies to support consumption of automobile and home appliances to be announced. These measures should support corporate earnings and prompt further equity market rerating.
* The world's major central banks have become more dovish. This week US Federal Reserve Chair Jerome Powell reiterated the Fed's patient, data-dependent stance in testimony to Congress. The hawks at the European Central Bank are sounding more dovish. Bundesbank President Jens Weidmann said that there was "much to suggest" that weakness in Germany's growth is persisting in 2019. And Bank of Japan (BoJ) Governor Haruhiko Kuroda said last week that the central bank might ease policy further if a strong yen hurts the economy.
* There is still upside potential for equity valuations. The offshore MSCI China Index is trading at around 10.9x its forward P/E, below the long-term average of 11.7x. The 12-month-trailing price-to-earnings (P/E) ratio for the S&P 500 is now around 17x, just above its average since 1960, but it often moves higher (median P/E close to 19x) when the Misery Index – the inflation rate plus the unemployment rate – is less than 6.5%.Against this backdrop, we believe that investors should filter out the noise of the news headlines and focus on the supportive fundamentals. We remain overweight equities, but also suggest holding hedges to protect the downside in case tail risks materialize.