2018 will likely be remembered as a year that investors in global markets would rather forget. Apart from a few isolated exceptions, investors would have been well served had they just parked their money in US dollars cash. Markets had plenty to worry about; but the reasons for the dismal performance we’ve seen can be mainly narrowed down to three: rising protectionism, slowing Chinese economic growth, and finally and probably most importantly, tightening monetary policy by the Federal Reserve.
Going into 2019 the questions on every investor’s mind is whether the New Year is going to be any different from the one just ended. To answer that question one needs to look again at whether 2019 will deliver more of the same, i.e. more political earthquakes, stuttering pace in the Chinese economic cycle and further tightening in US monetary policy.
It needs to be remembered that it was geopolitical shocks that have been the main driving force in the past two and half years or so. From Brexit to Trump to the 5 Star Movement in developed economies to Putin, Bolsonaro and Erdogan in developing ones, populism and strong-man politics have not been in short supply. The forces that gave us populism, namely a global financial crash and a subsequent rise in inequality, are still with us.
There are glimmers of hope, however. In the UK there is a steady movement against breaking off abruptly and completely from the EU; in the US the Republicans have lost their majority in the House of Representatives; and in Germany the right-wing Alternative for Germany lost ground to the Greens.
Turning to China it could be said that the seeds of the current wave of populist anger were sown when China was admitted to the global manufacturing system. This development led to a partial hollowing out of the industrial base in the Western hemisphere as global manufacturers set up complex supply chains, moving manufacturing jobs to the East. As China expanded its manufacturing capacity its indebtedness grew until the country came to a point where it realised that things had to change.
The current Chinese leadership started guiding the economy away from debt-fuelled growth. This reduced the need for commodity imports, hitting hard emerging economies dependent on commodity exports. Emerging assets were impacted negatively. With Xi Jinping appointed President for life, it is hard to see what is going to encourage China to reverse such a trend. This does not bode well for commodities in 2019, and by extension, countries reliant on exports of commodities. On the flip side, countries that are net commodity importers will see an improvement in their terms of trade supporting their currencies and assets.
Staying with commodities, if we are right that the Chinese economic backdrop will remain soft, oil prices are likely to stay contained as both demand and elevated supply will see to it. Oil production in Iran has been coming in above expectations, and US oil production remains at all-time highs. What happens to the price of oil matters a lot for us investors as it feeds into measured inflation, and in the US, industrial production and plant investment. The Fed pays attention to these.
The Fed has been tightening policy for a while, and at some point it was going to have an impact. What the Fed does from here on is very important. While the Federal Open Market Committee (FOMC) plans to lift rates by 0.75 per cent over the course of 2019, investors’ expectations are far lower. If the Fed defies market expectations asset markets are likely to experience turbulence. If on the other hand the Fed dials down its plans to raise interest rates, asset markets are likely to rally.
It is not just the Fed that is tightening policy. The ECB, through its decision to bring its balance sheet expansion to a close by the end of 2018 has also tightened policy. The ECB was a price insensitive buyer of bonds. This source of demand is not going to be there in 2019, and yet companies and governments have financing programmes to meet.
In May 2019 there are European elections taking place and we could get further polarisation, especially in Italy. If this happens and markets react accordingly, odds are the ECB will turn dovish.
What does all this mean for investors who have to put capital to work?
It is our view that 2019 is going to be another volatile year for investors. This should not surprise us as turbulence tends to pick up as we approach the late phase of the cycle. For the time being we continue to stay cautious on equities and bonds, especially those issued by companies labouring under high levels of indebtedness. These issuers could get hit by credit rating downgrades. Having said this, value is starting to appear in some pockets of the corporate bond market. Our view on the US dollar remains positive for the time being, and that will be the case for as long as the Federal Reserve carries on tightening policy or the outlook for the US economy stays better than that for the rest of the world.
Josef Portelli is head of Investment Management at APS Bank Ltd. Prior to joining APS he managed money in London for 13 years.
The information contained in this commentary represents the opinion of the contributor and is solely provided for information purposes. It is not to be interpreted as investment advice, or to be used or considered as an offer, or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments.
APS Bank Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.