2018 was an unusual year for investors. By the end of the year, both equities and bonds had delivered negative returns. Often bonds rise when equities fall and vice versa, but that wasn’t the case in 2018.
Another striking theme for the year was derating. Profits rose in many developed markets, but share prices didn’t rise in line with those growing profits. In other words, price/earnings ratios or ‘ratings’ fell.
So what’s going to happen in 2019?
Well, I’ve read notes by several investment banks and fund managers and I’m going to summarise some of their thoughts in this article. I’ll add in some of my opinions too. But please don’t treat this article as gospel truth. Pundits – including me – often get it wrong. This time last year, a majority of pundits said that emerging markets would perform well in 2018 and that’s not been the case at all.
Let’s start by looking at what may be the themes for 2019.
QT replaces QE
Monetary tightening is almost certainly going to be a big one. That means rising interest rates in the US, and possibly in some other developed markets as well. The US Fed has already begun to wind down Quantitative Easing (QE) and replace it with Quantitative Tightening (QT). In other words, the Fed is no longer buying bonds to add to its balance sheet. And when bonds that were bought post-2009 mature, they’re not all being replaced.
QE boosted asset prices a few years ago. It seems logical that QT will apply pressure the other way.
Geopolitics has been a much bigger factor for markets in 2018 than usual, and that will probably continue next year. I expect Trump to continue to make waves all over the place. He’ll carry on putting pressure on the Fed not to raise rates further, so that’s an important issue to watch.
It’s pretty clear that the US and European economies are in the ‘late cycle’ stage. The main signals telling us that are:
- The tight labour market
- Gently rising inflation
- Pick up in market volatility
- Flattening of the yield curve
Late cycle periods are inevitably followed by recessions, but you shouldn’t assume that a recession is imminent. The average length of the late cycle stage is around 18 months, so the good times could continue for a while yet. Goldman Sachs says it’s “too early to position for a downturn in global growth or corporate earnings.”
What’s more, stock markets often do well in the late cycle stage, according to BlackRock.
If you’re looking for signs of recession, Goldman Sachs says watch for these changes:
- Contracting profit margins
- Excessive central bank tightening
- Systemic financial imbalances
Thinking about where we are in the cycle doesn’t just help us predict when the next recession might come. It can also help us decide which investment factors – value, quality, etc -we should focus on for the next couple of years. More on that later.
Let’s now turn to the largest stock market in the world by far – the US.
Even after recent falls, the US market has still had a strong run over the last eight years and isn’t exactly cheap either. Slightly to my surprise though, BlackRock is still pretty positive on US equities. Nigel Bolton, who is one of the top fund managers at the firm, told journalists:
“Currently the p/e [price/earnings ratio] for the US market is 16 times – in line with long term average – not particularly cheap but we don’t think this is an environment where value per se is going to lead to outperformance, you do need some growth and that is one reason why we like the US market.”
He also thinks there will be something like $800 billion worth of share buybacks next year which should provide some sort of floor to US share prices. And, on top of that, Bolton is positive on technology, a sector where the US is very strong. He commented on tech companies: “generally balance sheets are still in pretty good shape‚Ä¶still see good underlying growth, don’t see a recession phase. Yes, there’s a slowdown, but it still has underlying growth coming through.”
Other folk aren’t so keen on the US though. Meb Faber, a well-respected US fund manager at Cambria Investment Management, reckons the US market is still over-valued after recent falls. You can hear Meb’s views in more detail on our latest Big Call Radio Show.
And Jim Leaviss, Head of Fixed Interest at M&G, thinks there are signs of an imminent recession in the US. He points out that American mortgage rates are at a seven-year high while the inventory of unsold housing stock is now at seven months – a ‘really high’ level last seen in 2011. Leaviss says this level is normally followed by a recession.
JP Morgan thinks there’s a 30% chance of a US recession in 2019, and a 60% chance in 2020.
Clearly, the likelihood of a US recession in 2019 is up for debate, but there’s a consensus that the US economy will at least slow down next year even if there isn’t a recession. Citi expects “growth to remain strong but begin to slow as the benefits from fiscal stimulus fade.” In other words, Trump’s tax cuts won’t make so much impact in 2019.
And, as I said earlier, rising interest rates are very much on the horizon. Capital Economics reckons there could be two more US rate rises by next summer, while Goldman Sachs thinks the dollar will fall because “moderation in US growth will overpower high rates as a driver of the US dollar.”
What about me?
I wrote last month that I had reduced my exposure to the US but hadn’t sold out completely, and that remains my view. I can’t completely sell out of a market that contains so many great global companies. That said,I agree with Meb Faber that US shares are still on the pricey side. If they fall another ten per cent next year, I’ll be tempted to top up. One thing I’m pretty confident about: volatility will be higher than we’ve been used to in recent years.
If you want to invest in the US, I highlight some attractive ETFs in the case for America.
In part two of this article, I look at prospects for emerging markets, Japan and Europe in 2019. I also discuss which investment factors are most likely to perform.