What's powering January's market rally?

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and Sophie Antal Gilbert, head of AIS business solutions, discussed the recent rally in equity markets, developments on the Brexit front and the impact of the U.S.-China trade war on consumer and business sentiment.

Markets on the rise, but declining consumer sentiment signals caution

After a brutal December for markets that saw the S&P 500® Index come within two-tenths of a percentage point of a bear market on Christmas Eve, equities have rallied significantly during the first half of January. The S&P 500, Ristuben said, is up roughly 12% from its Dec. 24 bottom, including an approximate 3% climb the week of Jan. 14 alone (as of midday Jan. 18). The STOXX® Europe 600 Index also rose nearly 3% from Jan. 14-18, with the MSCI Emerging Markets Index advancing roughly 1%. Why?

"One of the worries that helped spark the fourth-quarter selloff was that a recession may be lurking in 2019--a scenario which has never looked likely to our team of strategists at Russell Investments," Ristuben said. This month's market gains, he noted, are likely indicative of a broader realization that the economic outlook for 2019 isn't as pessimistic as originally feared by some. "This is in line with our thinking--that 2020, and not 2019, is when a U.S. recession is more likely," he stated.

That said, in Ristuben's opinion, the all-clear sign for markets has not been raised. Plunging consumer sentiment in the U.S., as evidenced by the latest data from the University of Michigan, is becoming a problem, Ristuben said. "While there are many possible factors contributing to this slump in confidence--including the ongoing trade conflict between the U.S. and China, Brexit and the current partial government shutdown in the U.S.--the fact of the matter is that when everyone starts acting like something bad is going to happen, markets take note and often react in a similarly negative fashion," he explained.

What's next for Brexit after Parliament rejects May's deal?

Shifting to Brexit, Ristuben said that in the wake of a resounding rejection by Parliament of UK Prime Minister Theresa May's Brexit deal, there now appear to be three options left on the table:

• A revised divorce agreement between the European Union (EU) and the UK;
• A no-deal Brexit, whereby the UK would crash out of the EU on March 29 without an agreement in place spelling out its future relationship with the EU; and
• No Brexit at all.

Interestingly enough, the results of a Jan. 16 poll by YouGov showed that 56% of Britons would back remaining in the EU were a second Brexit referendum put forth to voters, Ristuben said--potentially increasing the odds of a no Brexit outcome. However, the chances of such a referendum hinge on Labour Party leader Jeremy Corbyn being willing to call for one, he noted. "Overall, there does appear to be a growing probability that a light Brexit or a no Brexit may win out--but with the no-deal Brexit option still on the table, market concern isn't going anywhere," Ristuben concluded.

Do the U.S. and China have increasing incentive to strike a trade deal?

Trade relations between the U.S. and China, which have led to wild swings in markets the past several months, may be thawing out a bit as the two nations progress toward a potential resolution, Ristuben said. "In my view, both the U.S. and China have strong incentives to reach a deal," he stated, "given signs of a potential slowdown in the U.S. economy, coupled with the ongoing economic slump in China and the sour market response to the trade conflict."

Returning to the theme of sentiment, Ristuben concluded that although the trade war between the two nations hasn't directly impacted the U.S. economy so far, the sum of all the indirect impacts--such as waning consumer and business confidence--has clearly been negative.