2019 Outlook: active selection is essential

In the coming year, we expect to see lower correlations, higher volatility and lower returns, particularly for equities. Our 2019 outlook explores why active investing is likely to be essential.

In 2019, a fragmenting global economy means investors should aim to be more active and selective. While we don’t expect a US recession, politics in Europe may fuel market uncertainty. Meanwhile, China will continue its economic transformation, but tensions with the US will likely pose a threat.

President Trump will increase his focus on his 2020 re-election campaign. This may set up a battle between Mr Trump – as he pushes for more fiscal spending, lower taxes and new infrastructure projects – and the Fed, as it guides the US economy’s late-cycle turn.

Until now, Mr Trump’s stimulus package has had the upper hand: the booming economy reduced the unemployment rate to 3.7% in late October – a 48-year low. But overall inflation is likely to grind higher as tight labour markets push up wage inflation. This makes continued rate rises all the more likely, and the more cyclical parts of the US economy – like autos and housing – could react negatively. Moreover, continued trade tensions between the US and other countries could hurt all parties involved.

We expect the US economy to cool back down to a 2% growth rate, though we see no immediate signs of recession in 2019. A divided Congress may find common ground to revamp health-care costs, increase infrastructure spending and curtail Chinese access to US technology. Yet it will likely not pass additional tax-reform measures that would boost fiscal stimulus but further raise the deficit.

It is a year of reckoning for the UK, as 29 March 2019 marks its official exit from the European Union. How much of an exit deal is agreed by that point – and what decisions are kicked into the long grass – remains to be seen, but the country is likely to see further economic weakness if Brexit uncertainties drag on. The “tail risk” of a change of government will also add nervousness.

In the event of a “no-deal” outcome, the British pound and bond yields are likely to be down. UK assets in general are currently unloved and under-owned. How they perform in 2019 will depend as much on the end of the economic cycle as it will on Brexit uncertainty. Large, diversified exporters with significant non-EU business may be best-positioned.

While the region is currently doing fairly well, there are fault lines:

  • Signs of export weakness are hampering the German economic machine. A weakened German chancellor Angela Merkel, who has announced her political departure in 2021, may spell more trouble for Europe’s largest economy.
  • Tensions in Italy – and the showdown with the EU over its budget plans – may well prevent the EU from making much-needed reforms on the capital markets union, deposit union and common fiscal policies.
  • The May 2019 European Parliamentary elections will be an existential moment for the continent – a struggle between Eurosceptic populists and more mainstream, establishment candidates.

Where the EU goes from here will become a pressing topic, as it has yet to strengthen sufficiently the essential foundations that were shaken in the euro-zone crisis of 2010-2012. The EU remains sensitive to the growth momentum in the global economy, since exports underpin much of the region’s activity and investment.

Japan and the rest of Asia are linked to China’s fortunes, particularly as US influence in the region wanes. China’s “one belt, one road” series of strategic investments are an important source of funding for major infrastructure projects throughout the region.

Reform is another important theme – particularly in India and Indonesia, both of which will hold elections in 2019. Across the region, governments will strive for further economic liberalisation and structural reforms to underpin their growth. Those that succeed should find their efforts boosted by a young, hard-working millennial population.

China is committed to rebalancing its economy, emphasising consumption and services over exports. The country also wants to wean itself off high levels of debt – and encourage state-owned enterprises to maximise profits over employment. With these challenges, China certainly does not need a trade and tech war with the US.

Nevertheless, we believe China’s government can accomplish its goals in many ways. Its clear policies, determination and strong centralised leadership should help the country meet its economic targets. Large Chinese tech firms, like the BATs (Baidu, Alibaba, Tencent), may be more willing to align themselves with their own government than their US counterparts, the FANGs (Facebook, Amazon, Netflix, Google). The BATs also have better access to a larger regional market. Ultimately, China needs to avoid the low-income trap that has afflicted many emerging markets. That is why it is so focused on its “Made in China 2025” policies as it moves up the value-added chains of industry.

Some or all the securities identified and described may represent securities purchased in client accounts. The reader should not assume that an investment in the securities identified was or will be profitable. The securities or companies identified do not represent all of the securities purchased, sold, or recommended for advisory clients. Actual holdings will vary for each client. FANG is an acronym widely used on Wall Street and among many investors; it stands for four high performing large cap technology companies – Facebook, Amazon, Netflix and Google (now Alphabet) – that are also household names. BAT is a similarly widely used acronym for three large cap tech companies in China: Baidu, Alibaba and Tencent.

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