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Subdued economic backdrop and heightened geo-political uncertainty to continue to weigh on investor sentiment in 2019.
We expect the more subdued economic backdrop and heightened geo-political uncertainty that caused values to fall across many asset classes in 2018 to continue to weigh on investor sentiment in 2019. We expect this uncertainty to spark outbreaks of market volatility, despite the fact that the global economy is forecast to grow in 2019, albeit at a slower pace and more unevenly.
DIVERGENT GROWTH AND SLOWER PACE
Last October, the International Monetary Fund (IMF) shaved forecasts for global growth in 2019 to 3.7% from 3.9%, warning that growth is becoming less synchronised and more divergent.
On a positive note – we do not anticipate a recession in 2019 – either globally or in a major economy. Significantly, although the pace has slowed, the world economy is still growing at its highest rate since 2011. The world’s three biggest economies – the United States, China and Japan – are proving resilient, despite a deceleration in growth. The US economy remains supported by the residual effect of last year’s hefty tax cut package, rising corporate profits, rising wages and record low unemployment. China’s economy stands to gain from increased infrastructure spending, signs of a more relaxed approach to the value of the yuan, and a reduction in bank reserve requirements to stimulate bank lending. Meanwhile, Japan’s economy is benefiting from a focus on structural reforms, increased public spending, high productivity and a relatively robust corporate sector with significant cash reserves.
While the IMF trimmed 2019 growth forecasts for the United States and China (to 2.5% from 2.7% and to 6.2% from 6.4%, respectively), citing increased trade barriers and the likely impact of tightening financial conditions in key economies, we do not expect tariffs to be a major brake on economic growth for the US or China. Trade tensions will continue to simmer as brinkmanship between the superpowers persists, however. This uncertainty on trade and other critical geo-political issues contributed to a resurgence in market volatility last year, interrupting a nine-year run of steadily rising values and low volatility, and we expect this to continue in 2019.
WHAT IS HAPPENING IN US BOND MARKETS?
A big question is whether developments in the US Treasury bond market will augur badly for the US economy. At the heart of concerns is so-called ‘yield curve inversion.’ Bond yields move in opposite directions to bond prices, so when prices fall, yields rise and vice-versa. Yield inversion takes place when the yield on short-dated US Treasury bonds exceeds that of long-dated US Treasury bonds. Normally it is the other way around, as there are reckoned to be more risks associated with holding a bond for a longer time, reflected in a lower price but a higher yield for long-dated bonds compared to short-dated bonds.
Gyrations in US bond yields proved a disruptive force last year, illustrating how a jump to a perceived critical yield level can trigger both a bond and stock market sell-off. A yield curve inversion involving the yields on the 2-year and 10-year US Treasury notes is regarded as significant as it can be seen as a sign of impending recession.
Although we do not expect a US recession in 2019, we do regard certain assets such as US equities to be currently overvalued in relative terms, and expect that US share prices could fall further in 2019.
US share prices could fall further in 2019
ECONOMIC TROUBLE SPOTS REMAIN
Some countries are facing specific domestic economic, financial and political challenges, which explains the greater divergence in global economic fortunes. For example, Argentina and Turkey are struggling to overcome steep falls in the value of their currencies, spiralling inflation and a heavy debt burden.
Asset classes such as emerging markets lump very disparate economies together; however, within this group, some regions and nations are doing particularly well. Emerging and developing Asia is forecast to grow at 6.3% in 2019, which would make it the fastest growing region in the world. It has been boosted by a rise in intra-Asia trade, making it less reliant on developed economies. Some nations are running current account surpluses and have successfully reduced exposure to dollar-denominated debt – a boon at a time when the dollar is underpinned by rising US interest rates.
EUROZONE SLOWS BUT RATES SEEN AS STEADY
In the European Union, Italy’s economic growth and stability is a chief concern. Its planned budget deficit has brought it into conflict with the European Union amid concern over the high level of its public debt. The Eurozone has to contend with slower growth this year and the withdrawal of the European Central Bank’s bond-buying programme, and consequently interest rates in the region are unlikely to rise until late in the year at the earliest.
The Eurozone has to contend with slower growth this year
BREXIT WORRIES PERSIST
The vexed issue of the terms of the UK’s withdrawal from the European Union has imposed a ‘Brexit’ penalty on UK equities and on sterling, hobbling their progress last year and pushing UK shares to a 31% discount to global peers in valuation terms by late 2018 – close to a 30-year low. The outlook for UK assets is dependent on the outcome of protracted and tense Brexit negotiations and whether it ends with ‘no-deal’, ‘soft Brexit’, ‘hard Brexit’ or even a general election or second referendum.
The outlook for UK assets is dependent on the outcome of protracted and tense Brexit negotiations
HISTORICALLY LOW VALUATIONS PRESENT GROWTH OPPORTUNITIES
We believe that significant falls in share values in 2018, particularly in emerging market equities and UK equities, have created growth opportunities on a medium to long-term view, as valuations have fallen to historically low levels, making them attractive relative to global peers. Emerging market equities were among the biggest fallers of 2018 and we believe that they are now significantly undervalued relative to developed market equities. This was reflected in the changes we made in 2018 to our medium-term strategic asset allocation for multi-asset funds. As ever, we will continue to monitor market and economic developments, but remain committed to our long-term investment perspective.
We remain committed to our long-term investment perspective