After a year of synchronised global growth in 2017 and a strong start to 2018 for equity markets, the rest of the year proved tough for investors. A combination of fears; the trade war, rising populism, Brexit and an economic slowdown in China sent global stocks reeling.
Bond markets at least countered some of these risks in the three months to 31 December, posting minor gains amidst equity markets that lost between 7% and 20%. But there are potential flies in the fixed income ointment too.
Currently, there is a disconnect between fundamentals, which point to a positive economic outlook, and financial markets, which seem to be taking the opposite view, says Neil Birrell, chief investment officer at Premier Asset Management.
“Which is correct?” he asks. “Or is this just what we should expect when monetary policy is normalising after an unprecedented 10 or 11 years?”
We asked a selection of fund managers what they are watching out for in the coming 12 months.
Global Growth
Economic growth is a key concern for 2019 - particularly whether trade tensions will negatively impact regions on both sides of the globe.
Mike Bell, chief strategist at JP Morgan Asset Management, thinks US growth will fade through the course of the year. Child tax credits should hold growth up in the first six months, but that and last year’s tax cuts, which added 15% onto 2018’s growth figure, will fade completely later on.
David Zahn, head of European fixed income at Franklin Templeton, thinks GDP growth is key for Europe, too, as he considers it to the reason behind the market wobbles we’ve seen.
Growth softened in the second half of 2018, thanks to disappointing German auto sales in the third quarter of 2018 and political protests in France in the fourth. Zahn thinks these were isolated incidents and expects to see a rebound in growth through this year.
US Consumer Confidence
Bell has his eyes peeled for certain US data indicators this year. Earnings estimates are one, which we’ll know more about in the coming days and weeks. The labour market and Federal Reserve decisions will be important, too.
But he says he’ll be keeping a particularly close eye through the course of 2019 on US consumer confidence as a predictor of a potential recession, which he doesn’t see as being imminent.
Consumer confidence dropped off moderately in late 2018. If that turns into a more material downward trend, it “would be a risk that would be worth paying considerable attention to” as you tend to see a sharp fall in this indicator before a recession, says Bell.
But confidence remains higher than it has been since before the dotcom bust, led by tax cuts, a lower oil price – and, therefore gasoline prices – and a pick-up in wage growth. This suggests that we’re late-cycle rather than overdue a recession.
China Stimulus
China struggled in 2018; an escalating trade war with the US stifling sentiment and returns. The country had already been slowing through 2017 thanks to concerns over leverage and its shadow banking system.
But now, due to the trade issues, “China is firmly off the brake and back on the accelerator”, says Karen Ward, chief market strategist at JP Morgan.
While there’s a delicate balancing act, in part China will be posturing; trying to win against a US administration that wants to halt China's ascension to economic superpower. “The only thing they can hit back with is a demonstration that they will continue to grow and be an economic force to be reckoned with,” says Ward.
They have many more fiscal levers to pull than Western economies do, which Ward considers the beauty of being a command economy, which is where the government controls all aspects of the economy.
First, there’s a vast swathe of tax cuts due for the household and corporate sectors. Second, they’re ramping up infrastructure spending, including for rail projects.
Third, they have aggressively cut back their reserve requirement ratio – the amount of cash banks must hold as reserves. Having stood at 20% in 2015, it’s now down to 14.5% for large institutions and 12.5% for smaller banks, releasing billions of renminbi into the economy.
“Ultimately, I think they will be successful,” predicts Ward. “This is a face-saving exercise… and I think they will do whatever it takes.”
European Politics and Italy
European politics has dominated the Continental agenda for the past couple of years and 2019 will be no different. European Parliament elections in May will be key. Zahn expects the far-right and far-left populist parties to do well: “People will use it as a protest vote, although I don’t really think anything will radically change.”
It may lead, though, to the EU becoming more fiscally expansionary, as many countries begin to end austerity. We’ve seen already Italy get its way over its controversial budget and others could follow – including France.
A knock-on of this combination is that one of Italy’s governing coalition partners, the right-wing Lega Nord, has seen its popularity double in opinion polls since the election.
It could now call for a new election, in which it would probably come out on top and potentially form a more centre-right coalition. These tend to be more fiscally sensible, says Zahn, meaning bond markets would take confidence and Italian debt would do well.
Meanwhile, Tristan Hanson, multi-asset manager at M&G, thinks Italian equity valuations look attractive, at a seven-year low price/earnings multiple of 9.2 times. The aforementioned political improvements should alleviate some worries over the banking sector and even just a modest positive growth or earnings surprise should lead to “significant upside”.
The European Central Bank
Four tranches of long-term financing operations – a tool used by the ECB to provide eurozone banks with low-interest loans – worth €800 billion, are maturing in 2020.
Zahn expects the Bank to announce more tranches of LTROs in the first half of 2019 to remove some uncertainty and will be watching just how accommodative the terms are.
Meanwhile, following the US and others with a big lag, the ECB will be finishing its QE programme in December. Zahn is interested in seeing where they reinvest the cash they raise through this. He expects some to be funnelled into the corporate sector as well as into other Government securities.
Governor Mario Draghi will step down in November, so the ECB will start 2020 with a new head. While we’re not sure who that will be yet – Zahn thinks someone from Northern Europe – but their views will shape European monetary policy.
That said, while they are likely to be more hawkish on their home economy, “once they’re in charge of the ECB they will have to look at the bigger picture, look at the aggregate… and still be very accommodative”.
UK Property
UK property investors have many reasons for concern, says Rogier Quirijns, manager of the Cohen & Steers European Real Estate Securities Strategy.
UK commercial property was one of the few sectors that performed well in 2018, but Brexit casts a cloud over 2019 performance. While no-one knows how the market will be hit, “it is likely there will be a pause and more subdued property market activity”, says Calum Bruce, investment manager at Ediston Property.
Quirijns expects prime areas to feel the impact hardest. “London has been a beneficiary of the growth of the EU over the past three decades, but it will likely stagnate over the coming 10 years,” he predicts.
The disruption of the retail industry also poses problems, with retailers looking to streamline their store estate or drive down rents aggressively. E-commerce should thrive as a consequence and Bruce likes the retail warehouse space, while Quirijns is looking towards technology-related REITs.
