Investment Outlook 2019: Regime change

Out now: our take on markets and the economy and our asset class expectations

06 Dec 2018

Market volatility looks set to recur in 2019 as familiar factors such as tensions over international trade, diverging geopolitical views and a shift in monetary policy towards higher interest rates again roil investor sentiment. Beyond these known aspects, though, regime change is on the cards: two bull markets – the 30-year one in bonds and the decade-long one in US equities – appear to be ending, unwinding the asset class correlations that many investors have become used to.

Asset allocation views for 2019

In terms of our allocation views, we expect risky assets to face pressure from higher risk-free rates, but there should still be room for further equity appreciation. We expect support from the positive earnings and growth trend – foremost in the US – to outweigh concerns over monetary policy tightening, even in the face of gradually rising inflation, and slower, but still robust, growth.

We are opting to be neutral on equities. Europe or America first? For us, it is Europe, where equity valuations look more attractive.

We choose to be underweight in fixed income. Our focus would be on the eurozone as the ECB catches up with the US Federal Reserve, tightening policy as the need for central bank support in the form of quantitative easing fades.

Equally, we opt to be underweight in high-yield debt, particularly in the US. In Europe, the cycle looks more benign. Rising interest rates may cause problems in corporate debt markets. There has been a build-up in corporate leverage over the last few years and higher interest rates will put heavily indebted companies under pressure. Such pressures may be exacerbated by the fact that we are in the later stage of the economic cycle, so it should just be a matter of time before worries about growth drive investors to favour government bonds over corporate debt.

For emerging markets, renewed US dollar gains on the back of higher US interest rates and trade disputes could spark volatility and threaten performance, but overall, a broadly positive economic outlook would justify an upbeat longer-term assessment. Here, as with all asset classes, we expect 2019 to be a year favouring tactical allocations, stock-pickers and alpha-capable portfolio managers.

 

What is the economic outlook for 2019?

The US economy will continue to benefit from the US tax cuts and fiscal stimulus in 2019. With consensus forecasts for GDP growth of 2.6% in 2019 and 1.9% in 2020, recession is clearly not what economists expect. The economy is running at a healthy pace and US inflation is contained (allowing for only modest additional rate rises from the Fed), so a recession seems a reasonably distant prospect.

In developed economies outside the US, a recession appears even less likely. The recovery of the eurozone has been gradual and GDP growth is still below its level prior to the global financial crisis. Inflation remains well below the ECB’s target and there is still spare capacity in the economy.

China’s GDP growth may slow towards a low 6% rate in 2019, but it will still be a contributor to world growth, especially in emerging Asia. Nonetheless, rising interest rates in the US may put pressure on emerging markets as the US dollar appreciates further.

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