Chief Investment Strategist
We enter 2019 in a more circumspect mood than early 2018. A year ago, the global economy was performing strongly, and expectations of a bumper year for markets were high. In the event, 2018 was a year to forget for many, with low to negative returns across all major equity markets.
But last year holds a valuable lesson for investors. When expectations are high, the potential for disappointment is also high. Conversely, low expectations often herald a period of better market performance. There is no doubt that sentiment has been impacted by the weakness of markets into year-end. Fears over a slowing global economy, higher interest rates, and the risk of a trade war between the US and China are all cause for concern. But these last two factors will not necessarily come to pass, and global growth is still expected to remain positive.
We may not face as strong a backdrop as we did in 2018, but things still look encouraging. We are positive on the outlook for the coming year and believe equities could deliver reasonable returns, particularly given how attractive valuations are at the moment.
The catalyst for the sell-off in the final three months of 2018 was the Chairman of the Federal Reserve’s comment that interest rates were a long way from neutral. In this context, the neutral point is simply when interest rates are high enough to stop the economy from overheating and low enough not to choke off growth. Markets thought the economy was already slowing, and that significantly higher interest rates would weaken the economy more than the Federal Reserve (Fed) was anticipating.
In recent weeks, market concerns were exacerbated by Donald Trump’s attempt to pressure the Fed to back down on rate rises. Investors feared that the Fed would feel compelled to raise rates in an attempt to assert its independence – even if growth did weaken. However, recent comments from the Fed Chairman, Jerome Powell, suggest that the Fed will be more measured in its monetary stance, and will adjust policy in either direction as necessary during the course of the year.
The next likely opportunity to raise rates comes in March, by which point we will know more about the extent of the moderation in global growth, how trade tensions have affected the global economy so far, and whether Sino-American friction will continue going forward. It seems unlikely that we will see an aggressive stance from the Fed amidst a deteriorating trade environment.
Outside of the US, however, we expect central banks to largely stick by their existing decisions. The ECB ended its quantitative easing programme in December last year, but it is unlikely to raise interest rates this year, particularly given slower growth in the eurozone. The central bank is also reinvesting the proceeds of its bond portfolio, so European markets should continue to be supported for some time to come.
The current US-Sino trade tensions are a good example of what is known as a binary risk in markets, where the positive or negative outcome either will or will not happen. The probability of binary risks is typically difficult to assess, and the reward – or risk – of getting it wrong is usually high.
The arguments as to whether the US and China will manage to strike a deal are finely balanced. On the one hand, the US has set a high bar for the current trade talks, one that may be difficult to meet by early March when the trade truce runs out. If no resolution is found, then the US could impose tariffs of 25% on ca. half of China’s annual exports to the US as well as potentially levelling new tariffs on the remainder.
On the other hand, Trump will be keen to maintain his self-proclaimed reputation as a deal-maker. His Administration has already claimed credit for a successful renegotiation of the North American Free Trade Area, despite few substantive changes having been made. Trade is one of the areas the President has most influence over, being able to act almost unilaterally, and Trump may feel the need for a win as re-election draws closer. Markets are currently pricing in a cautious outlook on trade, so any positive news could remove a significant headwind to stock market performance.
While global economic activity is likely to moderate over the coming year, we still expect to see the world economy deliver positive growth. Indeed, we may actually see faster momentum in emerging markets, particularly if the US dollar weakens and oil prices remain low.
The outlook for corporate profits is also largely positive. Company analysts are currently estimating earnings per share growth of around 6-7% in every major investment region bar Japan, where estimates come in at a little over 2%. Couple this with the recent fall in share prices, and the valuations of most markets are looking attractive as expressed by forward price/earnings ratios.
The litmus test for markets over the next three months will be the financial results that companies report for the final quarter of 2018. Apple’s recent sales warning rattled investor sentiment. But while there may be more disappointments to come, we still expect profits to rise across the majority of industrial sectors this year.
March certainly has the potential to be one of the busiest months for news. By the end of the month, we will have a better sense of the likely path for US interest rates and whether the US and China have managed to come to a longer lasting truce over trade. We will also know if the UK is leaving the EU with a deal or not, or even postponing the whole event.
If the Withdrawal Agreement passes, however, it could be a catalyst for more positive feeling amongst investors globally. UK assets would react strongly, with domestic sectors like banks and housebuilders most exposed to a potential ‘Brexit bounce’.
In conclusion, markets will undoubtedly be more volatile in 2019 than in recent years. There are a number of events on the horizon that have fairly unpredictable outcomes and investor wariness has increased as a consequence. However, we still see attractive opportunities in many markets and continue to recommend the merits of holding a diversified portfolio invested across a range of asset classes.