What lies ahead in 2019? As we end 2018 there is a negative mood impacting equity indices across the globe and current market thinking about what the future may hold.
The world economy has in the bulk of recent years enjoyed the combination of a liquidity cycle and an earnings cycle, as accommodative monetary policies have provided a constructive backdrop for financial markets. Now, we have moved to a political and economic cycle.
The net effect of this is that politics has taken a more central role, as we have seen in the US and the UK, and this may be evidenced further in 2019, both here at home and in the EU. The economic cycle, meanwhile, focuses attention on where we are in the cycle. As worries about higher inflation ease, concerns about slower growth come more to the fore.
Could monetary policy tightening evoke the "r" word?
The main culprit is the monetary policy tightening that is happening across large parts of the world economy. This has already led to a slowdown. The “recession” word has crept into recent market commentary, which is indicative of how sentiment is changing.
Economic indicators are showing mixed signals. In particular, the surprise index of recent G10 indicators has slipped into negative territory, as data has turned out to be weaker than the market expected. Also, financial conditions have tightened, with rates rising, yield curves flattening and equities weakening, adding to recession concerns. The recession being feared is two successive negative quarters of growth, in the US and possibly elsewhere, not the outright collapse in global activity witnessed in 2009 following the global financial crisis.
Trade tensions persist, but otherwise global trade is robust
Market worries are also being compounded by fears about rising trade tensions between the US and China. Yet global trade has been relatively robust, and although just-in-time supply chains might suggest this is a good coincident indicator of still solid economic activity, there is uncertainty as to whether fears of future tariffs may have given an additional boost to trade now, to be offset by a slowdown in the new year.
Many commentators were caught out by the strength of the world economy towards the end of 2016, which continued through last year and the first half of 2018. Thus, such concern needs to put in this context of a recent period of strong global growth.
A slowdown is likely, but we are wary of self-fulfilling prophecies
Our overall message is to expect a global slowdown, from a strong to a steadier pace, not a collapse in economic activity. In the past, how this unfolds has been heavily influenced by policy and sentiment. Hence, when economies enter a new year in a negative frame of mind it is important not to dismiss the negative mood – it can become self-fulfilling.
Meanwhile, there are still many longer-term positive drivers that we should not lose sight of. These are linked to the fourth industrial revolution and a plethora of areas within that, such as the digital and data revolution and technological innovation – as well as key regional developments such as China’s Belt and Road Initiative. The other big global drivers to watch in 2019 include China’s policy attempts to underpin its growth and the underlying economic tensions in the euro area.
Also, while healthy labour markets in western economies point to rising wage growth, we are not expecting an acceleration of inflation. We expect inflation to remain relatively subdued, as the same factors such as globalisation and technology that have kept inflation in check remain in place. Although inflation may rise temporarily, the recent softness of oil prices is consistent with inflation remaining low.
Cheap money has left markets and economies vulnerable
The big unknown is the scale of monetary policy normalisation, reflecting concerns we have highlighted for some time. The over-dependence on cheap money policies in the years following the 2008 crisis has left financial markets and economies vulnerable to policy tightening. Part of the challenge is the apparent thinking that policy needs to be tighter, including rates higher, to provide scope to ease if a downturn comes.
In 2019 the US Federal Reserve (the Fed) is entering its fifth year of what has been gradual and predictable tightening to date. US rates should peak in 2019. Meanwhile, other central banks like the Bank of England (BOE), while tightening, are not as far advanced as the Fed. The BOE should keep rates on hold in the early part of the year, with a bias towards easing if the economy needs a post-Brexit boost. If, however, all goes smoothly, and there is a post-exit bounce in activity, it may resume its rate tightening later in 2019.
How fundamentals, policy and confidence interact is key
The global outlook depends upon the interaction between the fundamentals, policy and confidence. Here in the UK, the additional major feature impacting all of these is Brexit. Different scenarios may be needed given the Brexit profile.
The economy could easily come to a standstill in the early months, as political uncertainty overshadows all else. Although the solid UK labour market and rising wage growth could underpin consumption, household spending may be soft in the early months of the year, with a near-term rise in savings.
Investment plans, too, may be on hold. Sterling, meanwhile, remains competitive, but export growth will be impacted heavily by the trend for world trade. While uncertainty may weigh on the economy until there is greater clarity about what lies ahead, once there is certainty that could lead to a rebound in activity.
This time a year ago, one of the big issues was whether bonds were about to enter a bear market. We did not think so, although we were cautious about their immediate outlook in the subsequent few months. Now, one of the issues is whether equities, after their recent sell-off, are entering a bear market. Likewise, our view is no, but there is a need to be wary in the near term given current sentiment.
Yet if our current analysis is correct, longer-term value will prevail. The main message is that this is an environment to favour a diversified asset allocation.
Please remember that when investing your capital is at risk.