Outlook for 2019 – markets and economy
Dr Frank Engels has been a member of the Board of Managing Directors of Union Investment Privatfonds GmbH since 2014 and has headed up portfolio management at Union Investment since 2018. He is also responsible for the multi-asset business within portfolio management, having taken charge of this area in January 2017. He is chairman and one of the six voting members of the Union Investment Committee (UIC).
The markets in a late-cycle environment
Economic conditions are changing and although the global economy is set to continue growing next year, the late-cycle economic phase will be the dominant factor in 2019. One of the key drivers for the capital markets will be the question as to the longevity of the US economic cycle. The world’s largest economy is experiencing its second-longest expansion of the past 70 years, but indications of a marked slowdown in the US economy are currently increasing. As a result, we believe the pace of growth will tail off in 2019, creating a headwind for the capital markets. However, we do not expect the US economy to slip into recession. We are forecasting growth of around 2.5 per cent for the US next year, followed by a further slowdown in 2020.
Long but weak upturn
Economic conditions are becoming more challenging in other regions too, especially Europe. Next year, European gross domestic product is only predicted to rise by just over 1.5 per cent, so the discrepancy between growth rates in the US and Europe is here to stay. With a rate of 1.7 per cent, Germany is expected to maintain its steady economic expansion but will not be able to maintain the strong pace seen in recent years due to the unusual situation in its automotive sector and the softening of foreign trade as a result of increasing protectionism.
Europe will have to cope with political risk premiums
The situation is compounded by the political uncertainties in Europe. Brexit, in particular, has hit a logjam. The agreement reached between the EU and the UK government still needs to be approved by the parliament in Westminster. However, MPs are taking extremely contradictory stances on the negotiations and there is currently no sign of a majority in favour of May’s deal. The longer the uncertainty persists, the bigger the economic damage will be – particularly for the UK. The political situation in Italy and France also remains precarious. Ahead of the European elections in May 2019, Italy’s populist coalition government and the European Commission could potentially reach a compromise in regard to the country’s proposed budget deficit. But the dispute is likely to continue for the time being and uncertainty will remain high, as the deficit projections are based on unrealistically ambitious growth forecasts for the Italian economy.
Fed is in the pilot’s seat
The central banks therefore have a tough task on their hands. The US Federal Reserve wants to continue tightening its approach to monetary policy in an increasingly fragile environment. But there is a risk that the now more vulnerable economy will make it more difficult for the Fed to maintain its course. In view of the declining rates of growth at both global and domestic level, combined with heightened political risk, monetary policy is therefore likely to be tightened only moderately. The Fed is predicted to raise interest rates three times at most in 2019, but will increasingly stress its focus on the data. In other words, if US economic data looks to be weaker than expected going forward, a pause in the Fed’s cycle of interest-rate hikes will become more and more probable and will be communicated accordingly by the US central bank. On the other side of the Atlantic, the European Central Bank (ECB) will not change tack on interest rates or begin shifting the negative deposit rate towards the zero mark until the second half of 2019 at the earliest. Here too, we expect that the ECB’s response will be to communicate the delay or even suspension of its planned interest-rate rise in the event that overall demand falls more sharply than anticipated. Consequently, the monetary policy outlook for the capital markets remains only moderately restrictive overall.
It is thus clear that the economic climate and conditions in the capital markets will become even more challenging and present a more mixed picture in 2019. At the same time, they will become more susceptible to volatility. But this is not all bad news for investors, because bigger differences between regions, sectors and issuers are also a source of opportunity – especially for active managers. After all, activity beats volatility and selection uses rotation. These maxims are therefore likely to be the key to successful investing in 2019.
Selection is key
What does this actually mean? When it comes to equities and commodities, we regard phases of rising capital market prices as a selling opportunity (‘sell into strength’). They also enable us to act countercyclically and be better prepared for periods of falling prices. Overall, we expect prices in the equity markets to hold steady or decline slightly at index level, because corporate profits are becoming increasingly exposed to headwinds in the form of generally narrowing margins, while political uncertainties are making it ever harder for companies to plan ahead (due to protectionism, Brexit, sanctions imposed on Russia and Iran, etc.). At the same time, the differences between good and not so good business models will become increasingly apparent in terms of share prices. In other words, investors need to pick stocks carefully. Selection and tactics are also crucial when it comes to commodities, which are well supported late on in the cycle. This is because these markets are – and will continue to be – influenced by fundamental economic data and, above all, geopolitical factors.
Careful bond picking is also important, as the late-cycle economic phase means the bond market will increasingly distinguish between robust and weaker issuers. In the interest-rate markets, especially in the US, we predict that the yield curve will continue to flatten out, with yields rising only slightly on the whole. And in the eurozone, the ECB will only be able to go ahead with its first interest-rate hike in 2019 if the UK’s departure from the EU is not disorderly and if the economic and political situation in Italy, France and Germany does not deteriorate further. Moreover, the risk premiums on spread products in the US and eurozone bond markets are likely to see a further small increase due to the faltering rate of growth and the less supportive market indicators. Interest-rate duration rather than spread duration will thus become more and more important when constructing fixed-income and multi-asset portfolios. And in the currency market, the interest-rate support for the US dollar will increasingly lose its relevance in respect of the very important euro/US dollar exchange rate. The euro will also barely benefit from this in the coming months, but that is because of the political risks in the eurozone. By contrast, the emerging market currencies, which are heavily dependent on the US dollar exchange rate, are likely to continue stabilising over the course of the year.
As at: 12 December 2018.