Many of the same themes from 2018 are likely to play out, spelling a lot of tensions and suspense ahead
2018 was, undeniably, a year of action and volatility in the markets. Turmoil in global equities, brewing geopolitical storms, and populism all crashed to create negative returns across all asset classes, except for cash and government bonds.
“A lot of the same themes seem likely to play out in 2019,” noted Andrew Pease, global head of investment strategy for Russell Investments, in a recent commentary. “A significant difference, however, is that the year has begun with widespread investor pessimism, in contrast to the prevailing optimism at the beginning of 2018.”
Identifying Brexit as an investor theme to watch, he noted that while the outcome is difficult to predict, a soft-Brexit deal appears most likely. Should that happen, the pound sterling could rise in value against the US dollar, which would put pressure on the FTSE100 Index. “The economy isn't about to take off, but we think the Bank of England will probably manage one or two rate hikes if Brexit is indeed okay,” he said, predicting a modest rise toward 2.2% for gilts.
Italy, meanwhile, could potentially go very wrong. Aside from the government debt that’s 130% of GDP and the stagnant economy, he commented that the Italian bond market is “too large to fail and too big to save. “Italian 10-year yields are currently around 2.9%. We believe that Italy's banks could potentially become insolvent if the yield rises above 4%,” he said. He predicted that the country will act much like Greece in 2015, changing its policies to narrowly avoid a full-blown crisis.
He sounded out much louder alarms for China. He noted the economy’s dependence on state-owned banks lending money to state-owned enterprises and local governments at artificially low interest rates. The resulting debt load has left China’s central bank unable to pump up the economy nearly as well as it did in 2008 and 2015.
“China's share market fell 20% in 201810--the good news is that this means there may now be plenty of good stock-picking opportunities in China,” Pease said. “Nonetheless, we still believe that China's economy is going to remain lackluster.”
As for the risks from US President Donald Trump’s negotiations with other countries, he argued that rather than the economic impact of the trade war, the bigger worry is the prospect of increased military tensions as a result.
“For example, the South China Sea is an area of hotly contested sovereignty … In October 2018, a Chinese ship deliberately maneuvered across the bow of a U.S. ship and forced it to take evasive action,” he said. “An actual collision would have been a significant military incident and possibly a risk-off event for markets.”
Finally, Pease noted his firm’s view that the cycle is very late, with danger signals for the US around 2020. “Given that bear markets don’t usually start until around six months before a recession, we've probably got another year of okay, but volatile markets ahead of us,” he said. “[I] t's perfectly possible that a burst of late cycle euphoria drives equity markets substantially higher over 2019, but longer-term, we worry that the downside outweighs the upside.”
Follow WP on Facebook, LinkedIn and Twitter
