Global Market Perspective
Five key investment themes for 2019
Markets have entered 2019 in a state of heightened anxiety: these are the key factors on which concerns are now focused.
The world's economies and markets are increasingly interlinked, and subject to the same major themes and trends. As we start 2019, these are the among the most significant concerns for the year ahead.
The rift between the US and China over trade and tariffs became an increasing cause for concern in 2018. While in early December President Donald Trump and China’s President Xi Jinping agreed a trade “truce” at the G20 summit, the markets quickly became sceptical as to the scale of the commitment of either party.
When days later it emerged that a senior executive of one of China’s most significant technology firms, Huawei – which literally translates as “pride of China” – was arrested in Canada for alleged contravention of US sanctions, even more doubt was cast as to the durability of any agreement.
While national pride is clearly at stake on both sides, it is however in China’s interest to meet some of the US’s demands, although it would struggle to meet them all.
China is rapidly transforming itself into a global hub of technological innovation and so, for example, it would be in its own interests to support improved protection of intellectual property rights. It is also in China’s interest to attract more foreign capital.
Clearly, China is prepared to be accommodating – at least in some respects. Under the terms of the “truce”, it confirmed in December that it will start buying greater quantities of some US products, such as soybeans and liquid petroleum gas.
It also announced new penalties for intellectual property rights violations to be implemented within this year, with the Chinese Supreme Court establishing a specific body to oversee intellectual property disputes.
We expect China to meet “reasonable demands” made by the US. But the language used by China suggests it will resist some US demands – and the arrest of Huawei’s Chief Financial Officer will certainly be perceived as highly unreasonable.
It is difficult to determine an outcome within the 90-day period specified by December’s truce. Ultimately, the hurdles to be overcome are complex and there remains a lot of uncertainty.
Political risks loom on several fronts
Political developments in many parts of the world are likely to loom over markets and economic prospects in 2019. The Eurozone’s three biggest economies – Germany, France and Italy – are all experiencing a rising populist influence and a lack of strong leadership, posing a threat to the premise of European cohesion and integration.
In France, President Macron, embattled by repeated “Yellow Vest” protests, has seen his ratings nosedive to a record low of 20% – worse even than the ratings for the notoriously unpopular François Hollande. His structural reform agenda may now founder, with negative consequences for France’s long-term growth.
In Italy, although an agreement has been reached with the European Commission, the concern over the country’s debt sustainability has led to higher borrowing costs and pushed Italy to the verge of recession.
In Germany, Annegret Kramp-Karrenbauer has narrowly won the vote to succeed Angela Merkel as CDU leader. This reduces the risk of Merkel’s coalition falling apart, but it remains fragile.
In developing countries, key political events of 2019 include elections in Argentina and India. In Argentina, President Macri’s popularity has plunged along with the 50% crash in the peso. Inflation has surged to 40%.
If Macri is unable to win the election in October 2019, a populist candidate may derail current planned reforms despite high levels of public debt.
In India, Narendra Modi’s BJP government risks losing a majority in national elections in May. A hung parliament would not be positive for the Indian currency and economy.
Nations’ political cycles always involve risk. But risks become magnified where there is – as now – a backdrop of deteriorating trade and rising interest rates.
The all-important oil price
The oil price is always significant, but particularly in the late stages of an economic cycle – which is where we are at today. Crude oil prices have fallen by approximately a quarter since peaking in October 2018. This has led to a cooling in US inflation, where energy costs account for almost one tenth of the basket of prices tracked.
If oil prices were to rebound strongly in 2019 – especially if this came on top of fresh tariffs – it could usher in higher inflation. This would corner the Federal Reserve, which would need to battle inflation without putting too much of a brake on the economy and spooking financial markets.
Where will the oil price go? Crude’s recent 25% fall in just seven weeks was the sharpest sell-off in over a decade. Such weakness seems overdone. On the demand side, the Schroders commodities research team expects oil demand to stay relatively resilient in 2019, despite a weakening in global growth.
On the supply side, OPEC announced cuts at its December meeting, and production from Iran will fall in 2019. We are not expecting North American suppliers to flood the market this year, as these too have cut production.
The overall oil demand and supply balance is likely to remain tight in 2019. Given the sharp correction experienced in the latter stages of 2018, we may see a modest recovery in oil prices in 2019.
US economic growth starts to slow
The US enjoyed robust growth in 2018, mainly thanks to President Trump’s Tax Cuts and Jobs Act of 2017. We expect the benefits of this to wane. Political gridlock – following the mid-term election results in November – will limit the government’s ability to pass through further similar boosts. This should lead to slower growth in 2019.
Although most US economic indicators remain strong, in particular relating to the labour market, interest rate sensitive sectors such as housing are weakening. Weaker house price gains, volatile equity markets and higher costs of imported goods are all likely to dampen consumer spending in 2019.
Beyond the US there is mounting concern that growth elsewhere is also slowing. Data from Europe has been poor, with export-oriented Germany leading the slowdown.
Interest rates and the US dollar
Jerome Powell, the Chairman of the US Federal Reserve, said in a speech in late November that interest rates stood at “just below” what many economists estimate to be a “neutral” level.
Currently, the “neutral” position is reckoned at between 2.5% and 3.5%, while the actual rate sits at 2.5%, after the fourth rate increase in 2018.
Mr Powell’s “just below” comment suggested that the Federal Reserve is more inclined to pause its schedule of increases – or at least adopt a less determined stance on the need for further increases. The FOMC now expects two Fed funds rate increases in 2019, instead of three previously.
This is reflected in its more cautious economic forecasts, with both GDP growth and inflation revised down for 2018 and 2019.
Markets seemed more worried about economic outlook than the Fed, as they are now pricing only about half a rate increase in 2019, clearly well below that expected by the FOMC. If this less aggressive attitude toward rate rises unfolds, the dollar is likely to weaken in 2019.
This would be helpful to developing market assets, which tend to lift when the dollar falls – and which have suffered in the recent period of dollar strength.
Janet Mui, CFA is the global economist at Cazenove Capital, the wealth management division of Schroders. Janet is responsible for the formulation and communication of Cazenove’s top-down views. She is a member of the investment committee that oversees strategic and tactical asset allocation at Cazenove. Janet is also the macro spokesperson and a regular commentator at major media outlets including the BBC, Bloomberg and CNBC.