2018 was a year of extremes
It kicked off with a bang on expectations that synchronized growth experienced in 2017 would continue. However, concerns over global growth grew and investors shifted to profit taking and a risk-off mode.
The US and China trade tensions quickly escalated after a few rounds of tariffs. Geo-political issues shrouded Europe and dampened the economic outlook. In addition, the Federal Reserve raised rates four times tightening financial conditions.
Towards the end of 2018, almost all of the asset classes were in negative territory. This is unsurprising given the amount of negative news that has been priced in globally.
In fact, the returns across asset classes were virtually a mirror image of 2017’s (Chart 1).
Some crucial questions for investors now
· Is the U.S. late in the cycle? Or at the end of the cycle?
· On top of trade tensions, will China experience a bigger than expected slowdown because of the domestic deleveraging and social reforms?
We believe at this point the US is in the late cycle, but not the end of the cycle
Overall global economic growth will likely remain above 3%, which is definitely not in the recession territory yet.
However, we expect a synchronised economic slowdown in the US, Europe, and Japan. Emerging Markets could then see their growth differentials expand relative to developed markets. For example, growth could accelerate in Brazil (from 1.3% in 2018e to 3.0% in 2019e) and in India (from 7.4% in 2018e to 7.6% in 2019e).
While we expect two additional rate hikes by the Fed in 2019, there is a scenario, though not our base case, where the monetary policy tightening may ease as a more cautious strategy could be adopted given that the US economy is approaching the peak of the cycle.
This was recently confirmed by the “patient” Fed Chair Powell who has become more data dependent and signaled a temporary pause.
Another positive factor is that trade tensions are thawing somewhat and could lessen as the year progresses. Finally, real rates remain low after inflation. However, high volatility will likely remain throughout 2019 and investors need to react and adapt accordingly.
In our estimation, the probability of a recession in 2019 is clearly rising, but nonetheless, not at a critical level (Chart 2). We will be closely monitoring this going forward.
