2019 Outlook: Going to Hell in a Handbasket or Darkest Before the Dawn?
One is hesitant to add more verbiage to the 2019 Outlook pile but it has always been a useful exercise to put such thoughts down on paper and hopefully it will be of value to you, dear reader.
The plan is to utilize our proprietary Tri Polar World (TPW) framework with its three main regional poles: the Americas, Europe, and Asia together with our Global Risk Nexus (GRN) monitoring system that covers: Economics, Politics, Policy and Markets in each region to highlight the issues likely to drive markets in the year ahead.
In this way, we hope to convey not only our 2019 Outlook but also a good sense of how we at TPWIM approach the global, multi asset investment landscape.
ECONOMICS - STIMULUS, STABILITY OR RECESSION?
AMERICAS: US growth is clearly decelerating from its Q2 +4% peak, but a recession seems unlikely in the next year absent a major policy mistake (See Chart 1). The Fed’s decision to reduce 2019 expected hikes from 3 to 2 reduces that risk. We think a growth scare is more likely than recession, a growth scare that could elongate the expansion & thus prove quite beneficial. Trade uncertainty & weak oil prices are likely to dent the typical late cycle capex boom. Much will depend therefore on the consumer which with sub 4% unemployment should support 2.5% GDP growth. South of the border could surprise. Brazil is one of the few major world economies in a growth upcycle and Mexico’s 2019 budget assumptions seem responsible.
Chart 1:: US Recession more likely in 2020-2021
Source: Source: WSJ, FRB, BEA, FRB Chicago, Haver Analytics, Deutsche Bank
EUROPE: 2018 was either an economic disaster or a natural deceleration towards potential growth rates. We plump for the latter. Watch for wage gains and fiscal stimulus (Italy leads, France follows) to stabilize economic growth with ECB reinvestment providing back up. A weak Euro, low oil prices, and some trade stabilization provide further support to European growth prospects.
ASIA: China's mix of fiscal and monetary policy should be sufficient to stabilize growth absent further trade tariffs. Trade pressure prompts China to push for greater self-reliance including rebalancing more towards domestic consumption while moving upmarket in technology. Japan’s recent data feeds suggest an economic pickup while an aging & shrinking population leads to record low unemployment and wage gains to maintain growth. China-Japan rapprochement could benefit Japanese corporates. Weak oil prices help ASEAN as well as Japan, China.
POLITICS - MUELLER'S MOMENT, POPULISM EBBS, ELECTIONS MATTER
AMERICAS: Pres. Trump’s Mueller moment approaches and it may even be welcome given the drip, drip, drip of plea bargains and investigations across virtually all facets of Trump’s professional life. Watch the Republicans; Trump’s takeover of the Republican Party seems complete but politicians exist to get reelected and if Trump becomes a millstone rather than a launching pad watch out.
EUROPE: Could 2018 represent European populism’s high point? EU Parliament elections in May will tell the tale but Italy’s budget deal, EU approval polling at the highest levels since 1993 and more spending in several European countries could draw populism’s sting. Hungary’s recent anti Government protests could be the harbinger of populism’s ebb.
ASIA: In case one was ever in doubt, 2018 has taught that elections matter and the ones to pay attention to in Asia include: India, Indonesia and Thailand (making a return to democracy). Unrelated to elections but important to watch is the support for China’s Pres. Xi, virtually crowned Emperor for Life earlier this year but already facing disquiet over economic/trade woes.
POLICY - QE, QE, QE...QT, QT, QT…. FISCAL, FISCAL, FISCAL
AMERICAS: The US has had its fiscal party - could it be that a Fed pause is the key to the 2019 policy mix? The Fed views US growth as A ok while Equities and Treasuries response to Chair Powell’s press conference suggest the opposite. Both can’t be right. Gridlock (at best) is likely in DC and trillion dollar deficits suggest either a weak dollar or higher rates will be necessary to find buyers for all that paper.
EUROPE: Playing catch up to the US seems like Europe’s fate at least in terms of economic policy as 2019 sees the ECB exit QE while Europe finally enjoys some fiscal stimulus, borne out of desperation perhaps as in Italy and France but welcome nonetheless (See Chart 2). Coupled with wage gains running close to 3%, Europe's growth profile should be more in line with expectations. ECB remains supportive with its reinvestment policy.
Chart 2: Fiscal Policy Supports 2019 EU Growth
ASIA: If US stock market weakness suggests recession then by that logic shouldn’t China’s stock market bottoming in October suggest recovery in 2019? More likely to drive economic stability will be a combination of fiscal stimulus and monetary easing as China continues to operate as a “master juggler”. US trade policy towards China accelerates Asian regional integration as Chart 3 suggests.
Chart 3: US Trade Policy Serves to Accelerate Asian Regional Integration
Source: WSJ, Fitch Solutions
MARKETS - REVENGE OF THE REST OF THE WORLD?
Chart 4: 2019 RoW Growth To be Better Than US
Source: Morgan Stanley
EQUITY: US tech and momentum leadership is over which begs the question of what will replace it? Are we entering a bear market with low to negative real rates, 3% global growth, China stimulus, potential Fed pause, weak sentiment, light positioning, reasonable valuations and decent earnings growth? We think not, yet the failure of dovish Fed speak, China trade truce & OPEC production cuts to stabilize financial markets (let alone rally back to highs) is worrisome.
Chart 5: 2018 Pain to Lead to 2019 Gain?
It's a question of leadership - both country and sector. Can the Rest of the World lead while US equity flatlines (+/-5%) in 2019? ACWX has outperformed the US over the past one and three months, while EM equity appears to have already bottomed vs the US as shown in Chart 6. Areas of opportunity include: China, Latin America, Europe, and Japan. Fiscal stimulus in both China and Europe should support growth and hence risk assets. What about sector leadership? Tech is being repriced as a regional, rather than global, opportunity set (Splinternet) in terms of both supply chains and demand pools. Financials need to step up, as the growth scare abates and rates rise. Priced at roughly 0.5x TBV, European financials would seem a pretty reasonable risk - reward proposition.
Chart 6: EM First In Trouble, First Out?
FIXED INCOME: USTs and Bunds both hover at the lower ends of their trading ranges – we think it’s better to be a seller than a buyer at these levels. Bunds in particular are very exposed to almost any European good news on either the political or economic front. Credit has been universally disparaged. Absent a recession US HY seems interesting given its attractive supply/demand profile, very low default rates, lack of a refinancing mountain, and overhyped fear of BBB monsters (See Chart 7). EM debt is attractive both in USD and local currency. USD cash has been king the past few months but for how long will it continue?
Chart 7: BBB Monster Fears Overdone
Two-Year ‘BBB’ Potential Fallen Angel Debt In Next Recession
Note: Includes privately rated companies. (f) = Forecast financials
ALTS: OPEC production cuts should stabilize oil prices and support US MLPs which provide attractive risk -reward based opportunities. As Chart 8 suggests, current oil price levels also likely to cap US production.
Chart 8: US Crude Oil Production Rolling Over as Prices Fall
Better a gold bug than a bed bug as my Gramma used to say (not really but...). Low real rates, Fed likely to pause, geopolitical uncertainty wherever one looks, decent technicals, under owned and unappreciated - gold has a lot going for it. Industrial Metals and Mining opportunities depend largely on China demand and supply concerns.
FX: The over owned USD is at risk to Fed pause, better growth profile ex-US, and the flows that might go with it. On a First In, First Out, basis EMFX looks interesting given that it led markets into correction territory in the summer and bottomed several months ago. Many large emerging economies had an eventful 2018 and have adjusted accordingly.
Conclusion – Darkest Before The Dawn
Chart 9: Goodbye 2018 and Good Riddance!
Note: Returns are in USD. Data for 2018 as of mid-November (trust us things are worse now)
2018 has been a 1 in 100 kind of year as Chart 10 shows. What will 2019 bring? We think we are approaching the darkest before the dawn and Hell will be averted. The focus on QT needs balancing out with the return of fiscal stimulus in both Europe and Asia. Whether recent risk asset weakness is suggestive of recession or is more driven by market fears/internals remains an open question as is the prospect of non- US equity leadership. These are topics we will pick up in the New Year!
We hope you find this 2019 Outlook of value & thank you for all your support in our launch year! We look forward to more great engagement in 2019!
Enjoy a well deserved Holiday Break!
Jay Pelosky, CIO & Co-Founder
TPW Investment Management
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