Thoughts on the year that was and a look ahead to next year from Chief Economist Bevan Graham and Head of Investment Strategy Greg Fleming.
As the year draws to close it’s timely to reflect on the year that was and start to muse on the outlook for 2019.
It was a tough year for diversified investors. That’s despite the still solid macro-economic backdrop. Global growth looks to come in at around a solid 3.7% and profit growth remained strong. Inflation rose in the US but only to target and stayed low elsewhere. The US Federal Reserve raised interest rates four times as the economic backdrop allowed them to move interest rates closer to neutral. Monetary conditions remained stimulatory elsewhere, though the European Central Bank is on schedule to end its asset purchase programme by the end of the year.
But while the top level macro environment was good, there were a number of issues keeping markets unsettled:
- While top line global growth was relatively stable, the stability in developed market growth belied some underlying shift in momentum. Growth was stronger in the United States thanks to late cycle fiscal stimulus, but slowed in Europe and Japan.
- We expected President Trump’s trade war with China to step us we headed into November’s mid-term elections. We were not disappointed. Positive news in the last couple of weeks supports our theory the US will want to bring this to some conclusion sooner rather than later.
- Growth slowed in China, but no more than we were expecting. However, the trade war raised concerns about a more precipitous decline.
- President Trump’s political woes continued to be a slow burn as the Mueller enquiry continued. The Republican’s loss in the House of Representatives in the November mid-term elections means policy making will become more confrontational over the next two years, as we are already seeing with the risk of a pre-Christmas government shutdown.
- Politics in Europe were messy as Angela Merkel’s CDU party fared poorly in regional elections and Mrs Merkel announced she would not seek re-election as Chancellor at the next election. Italy’s new populist government attempted to get its 2019 Budget through the European Parliament, highlighting yet again the lack of, and need for, a comprehensive rules based fiscal strategy for the Eurozone. France was unsettled by riots triggered by the government’s economic reform agenda, and President Macron’s approval rating hit a fresh low.
- The shambles of Brexit became even more shambolic, threatening Theresa May’s hold on the Conservative party leadership and raising the spectre of fresh UK elections.
- Rising US interest rates and the stronger US dollar caused problems for emerging markets, especially those with ongoing structural weaknesses and/or high levels of US dollar denominated debt.
- Tightening global financial conditions through US interest rate moves and lessened central bank bond purchasing have fostered concerns that asset markets need to adjust to the end of the easy-money era which has insulated returns since the Global Financial Crisis.
All the worry delivered a volatile year, with periods of strength followed by periods of weakness as the worries came to the fore and markets were increasingly inclined towards ignoring good news and focusing on the bad. Indeed, as we approach the end of the year any hopes of a ‘Santa rally’ are fast fading with major global equity markets ending on their 2018 lows.
While international equity markets have struggled all year to sustain their periodic gains, the last three months has witnessed, as we expected, more outright weakness. This has moved beyond Europe, emerging markets and Japan, and is now affecting the key US indexes (which make up almost two-thirds of the developed market equity universe). We feel our cautious positioning throughout the year was justified and is still warranted, although the extent of over-valuation has now been reduced in many assets and early signs of value are finally emerging.
Into 2019, we expect the uncertainty to give way to the reality that while global growth may have passed its peak, it will remain solid. Furthermore, inflation is expected to remain low and monetary policy easy by historical standards. In the US we expect the US Federal Reserve to pause its rate hiking cycle while in China, further slowing of growth will likely result in additional stimulus. In New Zealand we expect growth to improve on the back of fiscal stimulus, but for inflation to remain benign and the RBNZ on hold.
Global shares may yet see new lows as uncertainty remains high, but as economic stability emerges and earnings growth remains reasonable, markets may equally consolidate sideways and even yet achieve final highs for this cycle. Returns from cash and fixed interest are expected to remain low. Given the more moderate interest track that we expect, it seems likely that listed real assets such as property and infrastructure can build on their recent resilience compared to broader equity markets, also benefiting from their more defensive qualities in uncertain times.
New Zealand assets still look robust compared to their international counterparts, with bonds in particular assisted by the strong fiscal situation. New Zealand equities could be challenged in retaining their record-high valuation level, though, if domestic growth and hence earnings are softer than investors currently expect. Headwinds from international equity weakness have barely registered in the New Zealand market so far, and this could change in 2019 if the recent rebound in NZD were to go further or households were to turn more cautious, which is not unlikely given the weight of negative headlines at present.
Commodities, which have cheapened further in 2018, could surprise next year if China manages to engineer a growth rebound and trade policy fears currently hanging over the global economy were to fade. High volatility in the oil price, however, suggests more clarity on growth is needed before any sustained improvement in global commodity prices gets underway.
For now, we hope you have a great Christmas and some time off with family and friends. We will be back in 2019 with everything you need to know about the outlook for the year ahead, including the Summer Edition of Taking Stock, the January edition of Quarterly Strategic Outlook and our Investment Outlook roadshow in February.
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