Can The Stock Market Rally Last?

December was the worst closing month of the year for Wall Street since the Great Depression back in the 1930s. It was a depressing end to a bad year that turned in the summer and led every major global equities market to losses over the entirety of 2018. The tailspin that started in September/October wiped out the gains of a positive first several months of the year. In the UK, the benchmark FTSE 100 index fell to a 12.5% loss, its most severe in a decade.

But January heralded a turnaround. Wall Street has just closed out its best start to the calendar year in 32 years. In the UK, the FTSE 100 managed to return almost 3.5% despite the chaos in parliament that resulted from Theresa May’s spectacularly failed attempt to harness support for the Brexit deal she negotiated at the end of 2018.

The rebound has been put down to three main catalysts. The first is markets rebalancing following a period during which they probably ‘oversold’ as pessimism kicked in late last year. It is thought the sell-off was further exaggerated by a large number of U.S. hedge funds liquidating around the same time after a decade of underperformance. The second catalyst was U.S.-China trade talks. These made some positive progress, if not concrete outcomes at this stage, calming market fears to some extent.

And finally, the U.S. Federal Reserve changed its tone to a more ‘doveish’ one. That culminated in a surprise move last week to hold interest rates at their present levels. Even more surprising was an about turn in forward guidance to the effect that two 2019 hikes are no longer expected and, rather, the current rate will be held. The Fed even indicated it could move to cut rates again, depending upon the economic outlook. Combined with statements around its intention to ‘be flexible’ in how it approaches selling the $4 trillion in Treasuries and mortgage-backed securities it bought in the wake of the 2008 crisis back to the market and a buoyant January jobs report, stock markets boomed on Thursday last week. The S&P 500 leapt 1.7% between the time the Fed announcement was made and the close of trading for the month.

As we begin February the question everyone investing online in capital markets will be asking themselves now is if the early 2019 rally can continue? Some are concerned that while the Fed’s unexpected change of policy will be welcomed by markets, it will lead to volatility and stores up problems for the future. The U.S. central bank stands accused of caving to the short term interests of investors and financial markets at the expense of long term financial stability.

With reporting season well underway, U.S. corporate earnings over the last three months of 2018 have not been particularly strong. China’s slowdown also looms over the world economy. If things do take a turn for the worse, the Fed doesn’t now have a lot of space to use lowering interest rates as a future stimulus tool, without it raising them further now. A strong dollar could also prove problematic for U.S. internationals this year. Amazon and U.S. pharmaceuticals giant Pfizer have already said they expect currency headwinds to impact their revenues this year.

The more optimistic among analysts say that underlying economic fundamentals still look strong. Quoted by The Times, Ethan Harris, a global economist at Bank of America Merrill Lynch outlined:

“Business cycles don’t die of old age, they die of excesses. Classic signs of ill health in an economy are an inflation-fighting central bank, a spending and financing bubble in a big sector of the economy and a spike in oil prices. None of these warning signs are flashing. The baseline is bullish.”