2018 was dominated by geo-political waves of market uncertainty, protectionism and trade wars.
As the year comes to an end, we look back at how global markets reacted and what the next few months could hold for investors.
Overall, the market landscape is set to venture deeper into a mature stage of the global economic cycle in 2019.This is especially the case for the US, which is more advanced in the cycle when compared with Europe, Japan and emerging markets (EM). Trade uncertainties are also weighing on the growth outlook and market sentiment. We face the prospect of higher inflation and policy rates against this backdrop, as well as the risks of inflection points in earnings and economic growth. It is a potent mix will likely result in greater market volatility.
Just as quantitative easing was hugely supportive of asset prices, the reverse of this dynamic will become increasingly true as growth moderates and central banks continue to gradually normalise their monetary policy.
We see some oxygen left for the equity markets and are selective of specific opportunities in the fixed income markets, such as EM high-yield (HY) bonds.
Alternative hedge fund strategies and unconstrained bond funds can offer attractive solutions for investors in the mature cycle as well.
Theme 1: Investing in the mature cycle
The global bull market is nearing 10 years of age and emerging from the ashes of the global financial crisis. History shows that the tricky hand-off from monetary accommodation to normalisation is often accompanied by policy overshooting.
With the absence of irrational exuberance, it is more likely that we will see a market characterised by heightened volatility and a broadly challenging environment for returns.
An important signpost for gauging how late we are in this cycle is profit margin contraction, particularly with rising wages, trade tariffs, higher borrowing costs and the tax cuts now behind us.
Theme 2: China’s reflation
As Chinese policy makers become increasingly concerned about slowing domestic growth, particularly as US tariffs continue to weigh, they have shifted focus from deleveraging the credit bubble to fiscal and monetary easing to limit growth decline.
China is widely expected to roll out more policy stimulus in 2019 to support growth.
Domestic economic activity slowed earlier in 2018 due to a mix of stricter regulations and monetary and credit tightening, as well as negative sentiments from escalating trade tensions with the US.
So far, the government has responded with a series of carefully calibrated and targeted policy-easing measures including cuts to banks’ reserve requirement ratios (RRR) and explicit instructions from top officials to banks to keep credit flowing to private enterprises.
Policymakers still have many tools at their disposal to further support growth such as accelerated infrastructure spending, further credit easing and tax cuts, and we expect more aggressive measures to be deployed progressively as we move through 2019.
Looking beyond the current slowdown, we continue to see solid long-term growth prospects for China, supported by further liberalisation and development of its capital markets and institutions, and the rise of China’s middle-class as a structural driver of demand and growth.
Theme 3: Industrial Revolution 4.0
Industrial revolution 4.0 is the trend of automation and data exchange in manufacturing technologies.
Fig 1: Industrial Revolution 4.0 – Rapid transition thanks to Mobile, Cloud and Big Data
Source: IBM, Allianz Global Investors
This includes the Internet of Things, cloud computing and artificial intelligence, and is introducing the “smart” factory concept through the use of cyber-physical systems to communicate and cooperate with each other and with humans in real time.
In following Moore’s law, the growth of Big Data has been relentless with 90% of the world’s data created in the last two years. The reinvention of transportation would also bring about promising developments in lithium batteries, shared mobility and driverless technologies.
According to IOT Analytics, over 2015-2018, the number of active IOT connections globally has increased almost doubled from 3.8 billion to 7b devices.
Theme 4: Opportunities in Europe
Europe is in an earlier stage of the economic recovery compared to the US, and its growth has been encouragingly broad-based thus far, with domestic demand as its main driver.
While European political risk is now heightened with the ongoing Italian budget crisis, we believe that this is already heavily discounted in markets and could present opportunities ahead.
Fig 2: Italian-German government bond spreads have widened significantly over 2018 YTD
Sources: Bloomberg, Bank of Singapore
Italy is the fourth-largest economy in the European Union, and with the UK – the third largest economy – on its way out as well as rising external pressure from Russia and the US, we believe the European Commission will accommodate Italy to preserve the integrity of the union.
Theme 5: Inflation rising
Inflation is a tail risk that investors should be watchful of. The US economy is at full capacity, unemployment rates are hitting its record lows, and wage growth is picking up.
Fig 3: US core inflation and wages are picking up
Sources: Bloomberg, Bank of Singapore
At this point in the cycle, workers can exploit their scarcity value and this has already started. Wage growth in the US, Europe and Japan is running at the fastest pace this cycle.
Furthermore, the US continues to grow above trend. Should the US economy heat up further, the intensification of demand-side activity and the scarcity of resources will lead to further inflationary pressure.
The wide-ranging implementation of tariffs by the White House would also have inflationary effects.Disclaimer applicable to recommendation
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