Global stock markets have rallied in the opening weeks of 2013 after a deal over the US fiscal cliff bolstered investors’ risk appetite. The S&P 500 is up 3.2% and the FTSE 100 has advanced 2.5%, while similar gains were made in the Euro Stoxx 50 and the Nikkei 225.
In his weekly investment commentary, Koesterich noted that two factors other than the fiscal cliff resolution aided the current rally – the so-called ‘January effect’ that often causes stocks to advance in the first month of the year and recent better-than-expected economic data.
“The question that clearly arises from all of this is whether or not the equity rally will continue,” the strategist said. “For the year as a whole, we would expect equity markets to continue to advance and to outperform bonds, with the best performance likely coming in emerging markets.
“That said, however, we expect the current pace of gains to slow – if not immediately, then probably by February.”
Koesterich said headline risk in the US is a reason for caution on risk assets in the coming few months, predicting “continued dysfunction” from US policymakers as they debate lifting the country’s debt ceiling, deal with scheduled spending cuts and work on its budget.
Meanwhile, political risk remains in Europe. If the Italian elections in February choose a less market-friendly government than the one currently headed by Mario Monti or fail to produce a clear result, then the markets are likely to react negatively.
In addition, Koesterich has “lingering concerns” about the US’ economic health and said data for the first quarter is likely to be relatively soft. One area of particular worry is consumption data, as Americans will be left with smaller pay cheques after being hit with higher taxes.
The VIX index – a widely followed measure of stock market volatility, which is also known as the ‘fear index’ – dropped to its lowest level since June 2007 last week.
“Although these risks are clearly evident, investors seem to be overly complacent,” Koesterich said. “To us, this suggests that there is not much bad news priced into market right now, meaning that any negative shock would have the potential to drive markets lower.”
