What will 2019 hold for investors? The question on everybody’s lips seems to be whether 2019 will herald the end of the cycle. We don’t think so. Rather, 2019 will be the year of transition. The year of lower but stable growth and rising inflation.
Yet we are in a different place from the start of 2018. No longer do we have synchronised global growth and central banks moving in tandem. Investors are likely to see rising dispersion among asset classes, regions and sectors in 2019 and volatility looks here to stay. Our economists predict that global GDP growth will remain relatively strong at 2.9% in 2019, only a small decline from 2018’s 3.1%. Investors need to keep a cool head, focus on fundamentals, remain open-minded and nimble in a market defined by jitters. Diversification and new, creative ways of finding alpha will be essential for positive returns.
Batten down the hatches – stormy seas ahead
Capital markets have been calm in recent years, but there are turbulent times ahead. The headwinds from political and macro risks are getting stronger, whether they come from Italy, Brexit or trade wars, so we will need to work harder and adapt our course to keep moving forward.
While growth is expected to slow, it’s important to remember it is coming down from high levels and we expect it to stabilize at relatively firm point. Yet 2019 will be far from a slam-dunk. A greater slowdown in China is a risk if the government provides a policy response that is too slow or too meagre. Further escalation of trade wars could hinder investment and cause rising cost pressures to depress historically high corporate margins. However, it could be better than expected and more fiscal easing outside of the US could help boost growth and support demand.
We think investors should keep the faith with risk assets such as equities but will need a careful eye to distinguish between short term noise and signs of changing long-term fundamentals.
Danger! Inflation ahead!
The greatest clear and present danger is inflation. We expect it to rise not just due to cyclical forces, such as strong labour markets and tight capacity, but also structural forces such as the rise in populism which doesn’t seem to be going away. Risk assets such as equities and credit will continue to grind higher, but along with it will come significant volatility consistent with late cycle dynamics.
However, duration could come under greater pressure. Rates are rising in the US and may start to do so in Europe in the latter half of 2019. Along with the Fed slimming its balance sheet and Europe ending its asset purchases, the supply of government debt is going to increase, leading to rising yields and tightening liquidity. If inflation persists, even as growth slows, central banks may have no choice but to continue on their path of interest-rate normalization. They will no longer be the backstop and ‘Get out of jail free’ card investors could rely on earlier in the cycle. This could mean that bonds will no longer be the equity protector to the same degree they once were.
Commodities typically provide diversification and do well in rising inflation environments, but we are more cautious this time round. The risk for 2019 is that the slowdown in growth, particularly in Emerging Markets, starts to hinder demand, compounded by trade tariffs will all put pressure on commodity producers. While commodities have a useful role to play, investors should be sensitive towards taking too heavy a position.
The hunt for returns is on
Quantitative easing and the subsequent uplift in global growth has provided a rising market that has lifted many investors. This will no longer be the case.
There will still be opportunities, but investors will need to hunt for them. Picking the right stocks and bonds is key and requires deep fundamental analysis. There will be more need for greater diversification through uncorrelated returns, such as through alternative risk premia to achieve hedge fund type returns and focusing on sorting the winners from the losers through high conviction active strategies.
As we move into the later part of the cycle, we favour equities over credit. The US HY market credit spreads have remained fairly firm this year, however we are cautious this could start to crack particularly if we see a deterioration in ratings in the expanded BBB part of the market. Since we expect a more volatile environment, we look to focus our equity exposure towards high-quality stable growth and more defensive sectors, as well as sourcing pockets of value, such as Emerging Markets.
While 2019 is not likely to be one where investors can sit back on their laurels, those who work for their returns and are prepared to hunt for them, will be justly rewarded.
Karen Watkin, Portfolio Manager, AllianceBernstein