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Don't worry about pullback

Three powerful forces supporting unusually long bull run

Global equity markets have gone without a 5 per cent drawdown for more than a year and they have not suffered a 10 per cent correction since the start of last year.

The stock market has powered through several surprise events - Brexit, United States President Donald Trump's election and North Korea's heightened belligerence - seemingly without missing a beat.

How are we to make sense of this unusual trend and how do we prepare for the inevitable pullback?

The enduring rally is being supported by three powerful forces - improving macroeconomic fundamentals, solid corporate earnings and abundant liquidity.

Starting with the macroeconomic backdrop: For the first time since the 2008 financial crisis, the world economy is seeing synchronised growth fuelled by both developed markets and emerging markets - a sea change from the aftermath of the crisis, when initially the emerging markets and later the US, took turns to support global growth.

Better still, the acceleration in global growth has been accompanied by weaker-than-expected inflation, creating the so-called "Goldilocks" environment - which is positive for risk-taking.

The favourable backdrop has filtered through to corporate profits.

For instance, consensus estimates indicate that the US, Euro area, Japan and China are all expected to report more than 10 per cent earnings growth this year and over the next 12 months, providing a fundamental support for equities.

And then there is the abundant global liquidity as a result of still-extremely accommodative monetary policies in most developed markets. The easy financial conditions worldwide are also reflected in the high levels of cash held by institutional investors, which have been deployed every time the market has suffered a hiccup. This has acted as a bulwark against deeper corrections over the past year.

So what could unsettle this constructive environment for equities? We believe there are two likely sources of near-term risk.

We expect inflation expectations to rise somewhat in the coming months. At some level, this may be reassuring, as it would resurrect the so-called Phillips curve - the long-held theoretical relationship between falling unemployment and rising wage pressures.

While the curve is not a precise tool when forecasting future inflation, the underlying theory behind the relationship remains valid - as job markets tighten across the developed economies, the risk of inflation picking up increases.

As inflation returns, more central banks are likely to focus on removing some of the monetary accommodation that has been in place following the global financial crisis. The central scenario is that this is likely to be a gradual process that gives ample time for markets to digest with limited volatility.

But there are always risks to this scenario. In any case, the process is likely to put gradual upward pressure on bond yields, making them increasingly competitive relative to expected returns from equities.

The second source of uncertainty is upcoming event risks, including increased tensions between the US and North Korea; the US debt ceiling debate and the Fed's start of balance sheet tightening; the European Central Bank starting to withdraw its ultra-loose monetary policy; and the US' more confrontational approach on trade issues.

The above factors may cause some indigestion for equity markets, but we do not believe they will be sufficient to derail the bull market for global equities, now in its ninth year, given the fundamental backdrop highlighted earlier.

Hence, we doubt that any pullback, while overdue, will be deep or prolonged.

The writer is chief investment strategist at Standard Chartered Private Bank. This article was published in The Business Times on Nov 8.

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