In 2018 market movements were mainly due to negative investor sentiment rather than actual negative data. Asset prices and market expectations in 2018 have adjusted significantly lower versus 2017, offering a better deal for investors and the potential for positive surprises. Although we are in the late stage of the economic cycle, we believe it is too early to position for a downturn in global growth or corporate earnings without clear signs of deteriorating fundamentals.
End of cycle signs include contracting corporate profit margins, excessive central bank tightening and systematic financial imbalances. Something, which we have not experienced in 2018 or expect to experience in 2019.
The late cycle environment may come with discussions around peak earnings. However, we believe these discussions are premature. Historically, margins have continued to expand until very close to the beginning of recessions.
Moving into 2019 we remain overweight equity exposure in a portfolio. Typical indicators around consumption, investment, and employment are not warning of recession. Inflation remains low enough for tightening to proceed gradually, and many assets have already moved to price in a more uncertain outlook.
We expect continued volatility: economic growth is slowing, central banks are tightening policy, and political risks all pose challenges, making hedging prudent.
Getting it wrong in 2018
We headed into 2018 with global growth strong and synchronised while market volatility and long-term bond yields were still low. However, the opposite happened during the year. At these levels the sell-off in 2018 was an over-reaction to the downside relative to the still growing (but slowing) global economy.
We expect these challenges will create fears about the end of the economic cycle and peak in corporate earnings but we believe there concerns are premature.
Economic growth
We expect global expansion to continue in 2019 and be driven by emerging markets. We believe the negative sentiment on a weakening Chinese economy is overdone and that continued positive support will lead to positive surprises.
From the US economy, we expect economic growth to continue albeit at a slower pace as fiscal stimulus fades and interest rates rise.
Politics
Politics continue to remain the main concern in the markets for 2019. However, we are of the view that positive news will come out of the trade talks in January and that major concerns about the trade war are overdone.
The political situation in Italy remains a risk on the economy. We will be monitoring the situations closely.
With respect to Brexit, given the recent sell-off in the markets, we expect the impact to be limited outside of the UK with the British Pound serving as the key shock absorber in negative scenarios.
Corporate earnings
Corporate earnings are likely to grow in 2019 not contract. More importantly, we so not expect to see excessive central bank tightening or systematic financial imbalances in 2019 that would warrant end-cycle fears.
Conclusion
We think investors will face more signs in 2019 that the long cycle is becoming stretched after a challenging 2018. These challenges have been accompanied by a significant shift in valuations. We think sentiment is overdone, lowering the bar for positive surprises.
Disclaimer:
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.