Global investment themes for 2019

As 2018 is coming to an end, various market participants would now be looking ahead for the start of the new year and examining the themes that are most likely to have the greatest impact on the performance of major asset classes over the next twelve months.

Across equity markets, following several months of relative calm, the recent prolonged surge in volatility has been truly remarkable. This was more pronounced is the US amid rising concerns over the pace of growth of the world’s largest economy which is in a late economic cycle, coupled with fading fiscal stimulus and an interest rate scenario which, in the words of the US Federal Reserve, is now close to the “neutral” level, meaning that interest rates are neither expansionary nor contractionary.

Against this background, and as trade tensions between the US and China continue to dominate headlines and pose several uncertainties worldwide, many financial analysts have been lowering expected profit margins, earnings and growth rates of numerous US multinationals. Automatically, this leads to the attribution of lower forward valuation multiples. Furthermore, sentiment towards three of the largest global technology stocks, namely Alphabet (the parent company of Google), Amazon and Apple, deteriorated significantly over the past three months for various reasons. These exerted a notable downward pressure on the performance of the three main equity indices in the US, namely the S&P 500, the Dow 30 and the Nasdaq 100. For instance, it is worth noting that on 3 October 2018, the share price of Apple recorded an all-time high of USD233.47. However, a series of disappointing developments, including lower forecasted earnings as well as a change in the intended way of how the company discloses the sources of its revenues, drove the equity price 24% lower into bear market territory. In the meantime, Apple also lost the title of the world’s most valuable company to Microsoft which, over the past three months, saw its market capitalisation “only” dwindle by 6% to just over USD853 billion. It is also interesting to note that the US treasury yield curve is now at its flattest point in over ten years which, in turn, suggests heightened perception of deteriorating economic conditions in the future. In fact, data shows that when the US yield curve is inverted (i.e. the yield on a 10-year US government bond is less than the yield on a 2-year Treasury), a recession generally followed.

Developments taking place in the US exert significant influence over the performance of financial markets across the rest of the world. For instance, emerging markets are important contributors to world economic growth as they represent a large addressable market and, unlike most developed economies, have high population growth rates such as in Brazil, Indonesia and South Asia. However, emerging markets are particularly vulnerable to adverse movements in the value of their respective currencies which, in turn, are also driven by the general attractiveness or otherwise of the US Dollar depending on economic conditions and the interest rate scenario in the US. Accordingly, a tighter monetary policy in the US encourages money outflows from emerging markets. Other factors that are likely to keep investors in emerging markets on edge in 2019 are overall macro-economic conditions (such as inflationary trends and current account deficits), issues of governance as well as fluctuations in the price of commodities. Particularly in the oil sector, it is important to highlight the market’s susceptibility to high volatility as also witnessed in recent weeks whereby the price of the benchmark West Texas Intermediate slumped from a four-year high of nearly USD77 back to the USD50 level (representing a decline of approximately 30%) in just three months.

In Europe, the biggest cause of uncertainty for 2019 seems to be Brexit. Although the EU and the UK government recently struck a deal for Brexit to happen on 29 March 2019 (as originally intended), the situation is nonetheless very fluid and complicated by political bickering within Theresa May’s own government and the House of Commons at large.

Beyond the UK, another important political event for 2019 is the European Parliament elections which are scheduled to take place between 23 and 26 May. Although this is not a theme that is now garnering much investor attention, it is worth recalling the dramatic rise of populist, anti-establishment and far right movements across Europe in recent years which, if fuelled further, could represent another source of uncertainty in the European political landscape over the coming months.

Furthermore, the biggest question mark for the euro area in 2019 from a financial and economic perspective is related to the likely path to be adopted by the European Central Bank when it comes to continuing normalising monetary policy. In this respect, although the central bank has, on various occasions, indicated its willingness to stop its Asset Purchase Programme at the end of this year, and also suggested an increase in key interest rates from the current record low levels in the second half of 2019, the views of several international analysts are largely mixed amid signs of growth fatigue across the euro economy.

Another important theme for the single currency area in 2019 is the extent to which Italy will succumb to demands by the European Commission to limit its fiscal deficit targets whilst, at the same time, kick-start an ailing and fragmented economy. In the meantime, Europe also needs to complete the establishment of the banking union as it represents a key measure for the euro area to strengthen its defences against possible systematic financial shocks in the future. In this regard, it is widely recognised that Europe’s banks lack scale, especially when compared to their US counterparts. Furthermore, after years of protracted deleveraging and cost-cutting measures, European banks are largely behind the curve when it comes to investment in technology. Profitability also remains a key challenge (as highlighted by the European Banking Authority in its most recent assessment of the sector) whilst cross-border consolidation among European banks continues to be a distant objective.

In China, financial market risks have also been on the increase amid signs of slowing economic growth (which, in turn, is delaying essential economic and financial reforms as recently highlighted by the international credit agency Standard & Poor's) as well as increasing debt sustainability concerns in both the public and private sectors. The latter is also due to the significant growth of the country’s vast shadow-banking sector in recent years which, according to Moody’s, another international credit rating agency, amounts to around 73% of China’s GDP. Against this background, it is worth referring to an article published by “The Economist” early last month which clearly stated that “what happens next in financial markets depends a lot on China”. In addition, it is also significant to note that China’s two main equity indices – namely the Shanghai and the Shenzhen composite indices – have been on a steady downward trend for the past year. In fact, the Shanghai Composite is now 27% lower from its most recent high which was recorded on 29 January 2018, whilst the Shenzhen Composite is in a worse position having suffered a 34% decline from its most recent high reached in mid-November 2017.

2019 is expected to be yet another eventful year characterised by several issues, namely a slowdown in global economic growth, international trade tensions, possible tighter monetary policies in the US and the euro area, Brexit, a mature equity bull market in the US coupled with various political issues including a potential political gridlock in the US Congress, as well as worries over the state of economic and financial affairs in China. Whether all these concerns will materialise is anyone’s guess, but the setting is clearly showing the need for market participants to be wary of current developments whilst always maintaining a long-term and disciplined approach to investing.

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