As we look around the world and digest recent key data releases, it becomes clear that markets continue to face a number of challenges. In the US, for example, earnings growth is likely to moderate after a strong year in 2018 as the tax reform tailwind fades, inflationary cost pressures build and slowing global trade hits revenue growth. Consensus is looking for 6% earnings per share (EPS) growth in the US in 2019, down from over 23% in 2018, however we think that forecast could prove optimistic.
On a more positive note, the Federal Reserve has pulled off a remarkable dovish U-turn in January, with consensus expectations moving from three hikes in 2019 to flat, more or less overnight. We expect no further rate hikes until September at the earliest, which may provide support for equities as fears of a policy mistake fade somewhat.
Trade tensions persist
A key driver of global macro uncertainty is the ongoing US-China trade war, in conjunction with weakening hard data on the Chinese economy. With the policy differentials between the US and China extending well beyond trade deficits into deeper-rooted differences over Intellectual Property (IP) protection and open market access, it would appear that a comprehensive resolution may be some way off.
While we don’t rule out temporary measures being agreed in March, it seems to us that following the January rally, markets are already discounting a relatively benign outcome. The Renminbi (RMB) will be interesting to watch - if further tariffs are implemented in March, as current policy dictates, we would likely see a RMB devaluation to allow Chinese exporters to remain competitive.
The debate over the Chinese economy is no longer whether or not growth is slowing, but on the timing and quantum of potential government stimulus. Some estimates put the size of proposed stimulus measures at around 5% of GDP, similar in size to the 2015/16 stimulus that resulted in a significant acceleration in the economy. However, with China’s current account surplus all but disappearing during 2018, recreating the stimulative measures of prior recoveries is made more difficult.
It appears the 2019 stimulus package will be more consumption-focussed through tax breaks for individuals and companies and less property focussed - yet, given property is 15% of Chinese GDP, the efficacy of consumption-led stimulus is hard to assess. Valuation of Chinese stocks is becoming more attractive, approaching trough levels of Price/Book, but with high volatility likely to persist, we will remain cautious until we see signs of improvement in leading indicators such as credit impulse and early-cycle hard data.
Tread carefully in Europe
Turning to Europe, uncertainty and caution is still the order of the day. Brexit continues to throw up more questions than answers, creating a very unhealthy environment for business confidence and investment. As a largely binary call on a long string of political negotiations, we prefer to take only modest risk in the UK.
Fundamentals in Europe don’t provide much more reason for optimism. Both Italy and Germany are facing technical recessions and have weak credit impulse numbers suggesting a difficult year ahead. However, with earnings growth forecast to be above the US in 2019 and with valuations below long-term averages and close to the lowest levels seen since 2012, we see opportunities in the region.
Away from regions, other notable topics discussed included oil, given the significant oil price decline seen in Q4 2018, which was one of the largest quarterly falls on record. We are constructive on the oil price as we move through 2019, with uncertainties over Venezuela and Iran supply likely to lead to a tighter market. Oil has also historically provided a good hedge against higher geopolitical uncertainty, which is seemingly likely to remain a consistent feature of 2019.
Reasons for cheer
There are however several reasons to be more constructive heading into 2019. Credit spreads, which are a widely watched indicator of economic health and investor sentiment, have tightened through January as the credit markets send a more positive signal in the US and Europe. Global economic surprise indicators are rebounding from low levels suggesting we may begin to see macro data improve through the year.
Lastly, equity valuations are below the average levels seen over the last three years, suggesting at least some of the bad news is priced in. This is not the case across the board - we note that the valuation spread between quality and value stocks has reached an all-time high, as heightened uncertainty drives investors to safe-haven stocks. In contrast, we believe this creates opportunities in over-sold and undervalued areas (such as cyclicals with China exposure) which is where we intend to focus our efforts in the quarter ahead.
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The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities/funds should not be construed as a recommendation to buy or sell these securities/funds and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.