Investors should steel themselves for a potentially bumpy ride in 2019, says James Bevan.
2018 was a challenging year for the global economy with slowing growth, tightening financial conditions and political developments that offered only uncertainty.
In the near term, the global economy looks likely to slow further.
But recently, markets appear to be entertaining the idea that policy could turn things around, and in seeking to understand whether the rally is for real, we see three policy areas that could affect the global economy in 2019 – the US, China, and Europe.
US growth has been reliable if not exciting in recent years, after the benefits of Mr Trump’s tax cuts and Jobs Act and the cross-party fiscal expansion.
However, we can expect growth to slow in 2019 as the effects of the fiscal stimulus fade and the capital expenditure cycle loses momentum.
That said, rising wage growth and lower oil prices should support consumer spending and prevent growth from slipping below trend and the Federal Reserve looks set to continue raising interest rates, but at a slower pace, in search of the so-called ‘neutral’ level.
With China, the economy has been slowing and we can expect the slowdown to continue through the first half of the year, with weakness spreading to real estate and manufacturing investment.
Policymakers are starting to respond with less conflicted stimulus measures than were offered last year, which should ultimately prove successful.
The gap between policy easing and economic recovery may be risky for the yuan, but a lower currency would also help the economy.
As for Europe, it looks set to be a “taker” of global growth, with weakness in the US and China weighing on activity.
But, unlike China and the US, monetary policy options look limited, and with the Eurozone, the Italian budget stand-off and looming European elections mean it is unlikely that other institutions will take up the reins.
This means we are unlikely to see counter-cyclical policies in 2019, with potential for more volatility.
Against this backdrop, and with concerns about valuations, future growth and macro-political developments, risk asset markets suffered a pullback in the fourth quarter of 2018.
But valuations are less rich, and whilst growth is slowing we see limited risk of an early global recession, along with some signs that the authorities are developing policies that will be positive for markets, including more accommodative commentary from the US Federal Reserve.
As to what all this means for markets, there are some indicators that suggest that the downturn is now over, including technical signals based on moving averages, shifts in portfolio positioning, the current strength of this rally, shifting central bank rhetoric, and the non-consensus nature of this view which means that the view can become self-feeding. We would presently regard this as a low probability scenario.
At the other end of the scale, it is possible that we are on the precipice of an ugly bear market.
We would put a low to medium probability on this scenario, recognising that if central banks are too slow to stimulate (or are not aggressive enough) bubbles could burst.
Cheap money has created bubbles, and its removal could be destructive – once bubbles have burst they are hard to control or offset and damage can be contagious.
Our
central scenario, is that we get a continuation of the current relief rally
into late January/February, followed by a topping out or rolling over, and then
weakness into March or April driven by falling liquidity, adverse fund flows
and tight credit.
That weakness may involve a retest of the S&P 500 lows or potentially plumbing
new lows.
The pattern of returns would be similar to what was experienced in 2015-16 but, consistent with our view that what the authorities do now is critical, we worry that money supply measures have become weak, with for example, global (GDP weighted) base money supply at its weakest since the global financial crisis.
We see the way forward for investors seeking decent income flows and long-term growth and prepared to put up with a bouncy ride, as focusing on a diversified set of assets where pricing is conservative, and underlying returns relatively assured.
If the global economy shoots up, this strategy would likely look very pedestrian, but in less clement market conditions it may shine.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
*CCLA is a supporter of Room151
