Five themes for 2019

Karen Ward of J.P. Morgan Asset Management, looks at five key themes for markets this year and reminds investors that this is not a time to be distracted by turbulence.

1. Europe is caught in the crossfire of a global trade downturn

US foreign policy proved particularly disruptive for markets in 2018. Undeterred by the threat of higher costs for US consumers and businesses, Washington ramped up trade tensions. 

This trade aggression hit the Chinese economy at a point when growth was already slowing rapidly in response to tighter policy from Beijing. The emerging markets have thus endured the double whammy of slowing growth in China and rising borrowing costs as a result of higher US interest rates. 

Although early tensions between the US and EU over auto tariffs have dissipated for now, European demand has been battered by a downturn in global trade. Strong US growth did not therefore trickle elsewhere as it has tended to in the past. 

2. The US fiscal sugar rush will fade

We don’t believe significant US economic outperformance will persist through the course of 2019. The fiscal stimulus that provided an intense sugar rush in 2018 is expected to fade in the coming quarters, and overall US GDP growth is expected to moderate to less than 2% by the end of 2019.

The tax cuts could have generated more lasting effects through increased business investment. But, in the face of geopolitical uncertainty, firms are now deferring investment. This is particularly disappointing because what the global economy desperately needs is stronger investment to revive potential growth, lift productivity and real wages, and in turn ease many of the political challenges. 

3. The Chinese authorities are back on the accelerator

While fiscal stimulus in the US is fading, Beijing’s policymakers have put their feet firmly back on the accelerator to see off the impact of slowing exports. Local government bond issuance is now ramping up to fund domestic infrastructure projects.

The Chinese authorities face a difficult balancing act of maintaining the “quality over quantity” agenda and reducing excesses in pockets of the economy, but at the same time sustaining a sufficient level of growth to support employment. Easing measures will be targeted and of a smaller scale than in 2008, but we expect growth to remain supported in the region of 6%. 

4. Brexit progress—but European challenges remain

European corporates are plagued not only by geopolitical uncertainty but also by political challenges at home. At the time of writing, there is still considerable uncertainty about Theresa May’s ability to pass the Brexit deal through parliament. Our baseline assumption is that the threat of either another referendum or a general election will eventually bind a majority in the House of Commons together.

Beyond Brexit, there are other challenges. With critical European Parliament elections coming up, the risks are rising that Eurosceptic alliances will take a greater share of the vote. The stand-off between Brussels and Rome also looks set to continue. We don’t expect Italy to consider leaving the euro, but the eurozone’s third-largest economy is slowing sharply as credit conditions tighten. 

These political fragilities could limit the ability of the European Central Bank to lift interest rates in the second half of the year in line with their current guidance. 

Although the eurozone domestic economy in aggregate looks fine for now and wages are rising, ongoing weakness in global trade is likely to deter firms from hiring, as well as investing. However, the recent collapse in the oil price is supportive, and consumers are still showing appetite to spend, so we expect European growth to hover at around 1.5% for much of 2019. That will be enough to see a sizeable narrowing between the performance of the European and US economies. 

5. Late-cycle asset allocation challenges

For equities, the convergence in GDP growth in the developed world should also coincide with a narrowing of relative earnings growth. Given that 73% of FTSE All-Share earnings are made overseas, UK investors will also need to bear in mind the potential implications of a positive Brexit outcome, which would be likely to result in higher sterling, hitting repatriated earnings. 
Valuations in emerging market equities look compelling, but there will need to be sufficient risk appetite for investors to confidently return. The ideal backdrop for emerging markets is one in which US economic growth slows to 2% but stabilises. 

At this stage of the cycle, when investors should be thinking about reducing the amount of risk in portfolios, it is natural to head towards the shelter of fixed income. But at this juncture, investors need to be careful about where they land. 

The quality of investment grade benchmarks has deteriorated considerably in the past decade. Fundamentals in the high yield market are less worrying today, but concern about the durability of the recovery and the potential for higher defaults may also weigh on the sector in time. And it will be important not to underestimate the influence of quantitative tightening on both the volatility and the absolute level of yields in fixed income. 

Conclusion: Travelling through turbulence

In 2019, it will be important to be wary of overreacting to political noise and opting for dramatic shifts in allocation. At this stage, we would consider relatively small changes to improve the resilience of a portfolio. Within equities, look for regional diversification and consider moving to larger cap stocks, with a bias towards quality and value over growth. Fixed income should play a greater role, but be selective and consider alternatives such as macro funds to add portfolio ballast.

Navigating a market cycle is a bit like flying a plane. The dangerous bits—the parts you really need to get right—are the take-off and landing. Investors need to have a closer eye on the controls and not be distracted by the usual turbulence as we pass down through the clouds. 


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