There were four main concerns for financial markets coming into 2019:
1. Monetary Policy:
After the December Fed rate hike, which most considered a policy mistake, Global Equity and Bond markets took a tumble, causing the Fed to shift its stance in January towards a much more dovish and patient approach. This includes a pause on rate hikes, with the market now pricing in a very low probability for hikes in 2019 and perhaps a rate cut in 2020, and an early end to the balance sheet unwind. To add to that the ECB has also communicated a dovish approach. This puts to rest, for now, the uncertainty surrounding central bank policy, a positive for markets. Stocks and bonds have recovered sharply from their December lows and seem to have fully priced in the dovishness.
2. Trade war
The trade war rhetoric continues to be an overhang for markets. There has been recent investor confidence in a final trade deal being announced sooner than later. However, the Trump-Xi meeting may be pushed back to at Least April. We believe it is actually in Trump’s interest to get a deal done given that he is up for re-election next year and is recent comments allude to an urgency for a deal to be finalized, but the posturing will continue on both sides in an effort to portray a tough stance especially for Trump to deliver a ‘win’ to his base. This will be a positive for affected sectors, especially in conjunction with a recovery in China.
Brexit is a big question mark with significant uncertainty around the actual outcome. The British parliament has ruled out a No-Deal Brexit, leaving either approval of the May deal or the parliament figuring out less disruptive option. Given the deadline is around the corner, and some solution needs to be passed in parliament and conveyed to the EU by the 12th of April. The EU continues to have the upper hand and an accidental hard exit is still possible if no deal is presented however it is in both the EU and UK’s interest to have an orderly exit. With hardcore Brexiters now aligning behind the May deal, the probability of some solution has risen and that remains our base case. Depending on what parliament votes for this week, we could even see a longer extension period being demanded and EU elections being held but the prospect of that would align Brexiters further behind May. We believe GBP volatility should continue to be high but the downside risk is reduced. UK equities are still offering relative value but concerns may arise again if political events lead to another election with a greater chance of a Labour government under Corbyn.
4. China Economic Slowdown
After years of high growth China is experiencing an expected slowdown. Being the second biggest economy in the world and a driver of global trade, we have also seen a slowdown in other economies that are highly levered to trade with China, Germany being a prime example. Germany faces the added effect of low consumer spending (though the savings rate is high) and lack of innovation that is needed to drive the next phase of growth for the Euro’s biggest economy.
The Chinese government is committed to diligently managing the slowdown using conventional and unconventional methods. Some of the stimulus measures have not seen the intended effects, however we believe the government will use whatever means they have to manage the slowdown and try and stimulate the economy. The current focus is on infrastructure spend and a renewed property stimulus. China is transitioning from a manufacturing/export led economy into a consumer driven one and given China’s mass middle class population and savings rate we believe this is a natural cycle that will take its course. We are already seeing a turnaround in Chinese consumption names and we still see value there.
In conclusion we believe, the elevated level of concerns coming into 2019 have somewhat
subsided. Market performance is testament to that. With most securities now fairly priced where we go from here is the question. Any positive news on Trade talks and/or Brexit (the timing of which is uncertain) could push markets further. On the flip side, negative news will have adverse effects but ultimately the investor concern will remain around the health of the global economy, the timing of the end to the current credit/economic cycle, which has been longer than history dictates and the health of corporate profitability.
The US economy has probably seen its peak and will see weaker growth in Q1 but it is too early to call an end to the US growth cycle – one last acceleration in second half 2019 before things start to slow in 2020 is for now the base case. We believe that based on current valuations and market complacency we could see a correction which would present an entry point for a second half rally to end the year.