Macro views

What’s next for Brexit?

On Tuesday, Parliament rejected U.K. Prime Minister Theresa May’s Brexit Withdrawal Bill by a 230-vote margin – the largest defeat of legislation in nearly 250 years, when Parliamentary records began.^† That the defeat exceeded consensus by as much as 100 votes reflects the depth and breadth of dissatisfaction with May’s Brexit plan. Many Members of Parliament (MPs) fear it could further undermine the economy, contribute to secession in Northern Ireland or Scotland, or might not confer the freedom for which Brexiters campaigned in the referendum.

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Investor sentiment stays positive despite geopolitical drama

There has been no shortage of drama across the macroeconomic and geopolitical landscape so far in 2019. However, it appears that investors may be tuning out much of the political theatre around them. Which storylines are moving markets now, and which may become more integral to the plot in the weeks ahead?

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Is a real winner possible in the U.S.-China trade war?

Students of history may recall the War of the Roses, which was waged more than 500 years ago. It was an epic battle between two rival branches of the English royal family that both had claims to England’s throne – the House of Lancaster, represented by a red rose, and the House of York, represented by a white rose. While the House of Lancaster ultimately won the War of the Roses, by some measures there was no real winner. The war lasted for many years and resulted in very significant damage to both houses. In fact, by the end of the war, the male lines in both houses had been eliminated.

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No holiday in sight for global disruption

At the start of 2018, I warned about two significant forms of disruption that posed risks to markets: geopolitical disruption and monetary policy disruption. The solution to the global financial crisis – experimental monetary policy – had created greater wealth inequality, which had led to geopolitical disruption, and the situation was poised to worsen in 2018. This experimental monetary policy, especially large-scale asset purchases, was beginning to be unwound – and that was an experiment in and of itself which also had the potential to cause disruption.

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Three themes we’re watching in 2019, and their implications for institutional investors

As we look toward the opportunities and challenges to come in 2019, our base case is positive, with the expectation that global economic growth is likely to decelerate modestly, yet remain solid. We expect major economies to slow from above-trend growth toward on-trend growth, which should contain inflation, as major central banks normalize policy.

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Fixed income: Gauging the ripple effects of softening economic growth

Key takeaways

• In the US, we believe peak levels of growth are behind us and expect to see slowing in the second half of 2019.
• Outside the US, there are also signs of softening growth.
• Inflation is likely to increase somewhat, but we do not believe that wage inflation will be significantly passed through to consumer prices in 2019.

Global macro

In the US, we believe peak levels of growth are behind us, although we expect annual growth of around 2.75% to persist through the first half of 2019 before slowing.  Fiscal stimulus is still having a positive effect on growth, but will likely wane in the second half of 2019.  In addition, the positive financial tailwinds that have been driving the economy may turn more neutral as monetary policy continues to tighten.  Therefore, while consumer spending will likely be additive to growth in the first half, as the boost from tax cuts winds down, the question is how much will the consumer want to spend thereafter? Consumption has grown at an unsustainably high level, in our view, over the last several quarters, driven by stronger consumer confidence and tax cuts. A meaningful slowdown in consumption could have negative implications for broader growth.  These effects mean that risks to economic growth are higher in late 2019 than they have been in previous points in the cycle.

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International growth equities: A supportive outlook for international earnings

Key takeaways

• Despite the soft patch in certain macro indicators, there is a broad expectation that most major regions may deliver solid earnings growth in 2019.
• We believe equity valuations remain vulnerable to higher bond yields and discount rates.
• Trade and geopolitical tensions are the primary threats to the growth outlook.

As 2018 draws to a close, strong US corporate cash flow has been well-supported by tax cuts and increasing fiscal spending. This may continue to underpin reasonably healthy capital expenditures and support economic growth and earnings delivery in the US — but the big question is, will growth pick up around the world?

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U.S. growth equities: Change is the fuel for growth

Key takeaways

• If historical precedent holds up, there is still room to be positive on equities as we move into 2019 and on to early 2020.
• The key is to identify companies that can gain market share from technology-enabled advantages in their business model or disruptive shifts in consumer behavior.
• We highlight several areas where technology is enabling disruption and creating opportunities.

As we look forward into 2019, we believe there is continued potential for positive US equity returns, but slowing economic growth may mean more frequent downhills — and more investors losing their way — than during the market’s climb of recent years.  Observing the weight of the evidence, we have moved into a late-cycle environment.  In our view, the path forward will not rely on choosing growth versus value, or small-cap versus large-cap. We believe it will rely on identifying “share-takers” (companies that can gain market share from technology-enabled advantages in their business model and in consumer behavior) and avoiding “share-losers” (companies that have simply been buoyed in recent years by the expanding economic environment).

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Exchange-traded funds: Strategies for mitigating the new risks of the new year

Key Takeaways

• We see new risks on the horizon for both equity and fixed income investors, but there are various exchange-traded fund strategies that we believe can help.
• We expect that a loss of profit momentum in 2019 could lead to increased volatility and correlations, and we believe that the Low Volatility and Quality factors may perform relatively well in such an environment.
• With the overall climate still tilting in the direction of higher rates in 2019, one way to potentially manage that risk is to build bond ladders using defined-maturity bond funds.

In the new year, we see new risks on the horizon for both equity and fixed income investors. Equity markets are anticipating a loss of momentum for corporate profit growth. And, for the first time in 12 years, fixed income investors are forced to wrestle with the challenge of navigating a multi-year upward trend in interest rates at both the short and long end of the bond universe. There are various exchange-traded fund strategies that we believe can help with both challenges.

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Solutions: Heading into an uncertain 2019, diversification must be top-of-mind

Key takeaways

• The road ahead is expected to be challenging due to a variety of factors: rising global interest rates, increased volatility, diverging global monetary policies, and heightened geopolitical tensions around trade and tariffs.
• Our forecasts for returns are tepid across the major asset classes.
• There remain pockets of opportunities within asset classes.

Heading into 2019, the market’s resiliency is likely to be tested by evolving geopolitical tensions and questions regarding the ability of a late stage economy to grow. Volatility is expected to remain elevated as the markets seek additional support for increasing asset prices beyond continued earnings growth and the perceived positive impact of tax cuts. However, the road ahead will likely be more challenging to navigate. While the economy, as measured by gross domestic product, continues to expand, and US equities are experiencing their second largest expansion in recent history, there are numerous challenges for investors to navigate going forward, including:

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Global economy: Global economy expected to grow with low inflation in 2019

Key takeaways

• 2018 has been a year of turmoil, but, 2019 promises to be much calmer, in my view.
• I believe the Federal Reserve should be successful in positioning the US economy for several more years of expansion.
• Monetary policy invariably dominates fiscal policy in the determination of inflation

2018 has been a year of turmoil with weakness in the bond markets and two significant sell-offs in equity markets. In between there were crises in Venezuela, Argentina and Turkey; ongoing Brexit negotiations; a strong rise in the price of oil; and disruptions created by US President Donald’s Trump’s repeated trade measures — all set against a backdrop normalising US interest rates. However, 2019 promises to be much calmer, in my view.

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Emerging markets: No shortage of reasons to be cautious in 2019

Key takeaways

• Emerging Markets (EM) face high uncertainty due to US equity market volatility and trade wars.
• Yet we believe EMs as an asset class looks attractive as they are quite undervalued.
• Quality has been out of favor in the EM markets in 2018, but we anticipate a reverse to the mean in the near future.

Emerging markets are one of the few asset classes where informational inefficiencies provide a fertile ground for bottom-up stock pickers (i.e., active investors) to add value. In our opinion, demographics, technology, decreased reliance on commodities and globalization all provide visible long-term growth potential.

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Multi-asset: The prolonged global expansion could continue if fiscal and monetary policies remain supportive

Key takeaways

• We take a two- to three-year view of the world when building our central economic thesis.
• We believe it is vital to consider both cyclical and structural forces in building this thesis.
• We believe that all of our ideas can make a positive return in our central economic scenario to ensure we have ideas that can excel in various economic conditions. However, it is important to note that our ideas do not derive from it.

2018 has been a relatively volatile year, however this has been limited to bouts of volatility while, rather surprisingly, levels of market volatility overall have remained fairly subdued.

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Alternatives: Alternatives may be an answer to challenging investment environments

Key takeaways

• Expect lower equity returns, increased volatility and rising interest rates in 2019.
• Alternative investments can help investors weather a more challenging environment.
• Investors need to be proactive and avoid the mistake of adding alternatives reactively.

Following an idyllic 2017, when equity markets were characterized by strong returns and low volatility, we were reminded in 2018 that markets are often volatile and can go down just as easily as up. In 2019, I believe investors should be preparing themselves for lower equity returns, increased volatility and rising interest rates. Given this outlook, investors would be well-served (in my opinion) to consider the addition of alternative investments to their portfolios.

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Real estate: The outlook for real estate fundamentals is positive, but risks remain

Key takeaways

• Risks today are crystallizing; many are more global in nature.
• Pricing remains attractive; however, yield/cap rate compression is largely behind us.
• Total returns in 2019 are likely to be driven by net operating income growth.

Strong growth in developed economies should continue to support favorable real estate fundamentals in the near term. The baseline scenario remains very positive, and global listed equities’ earnings yields are providing a positive spread over local government bonds, a sign that real estate is still fairly priced. Yet macro risks to the outlook are perhaps now greater today than in prior years; many are increasingly global in nature. They include rising populism, an escalation of the US-China trade war, a monetary policy normalization misstep, a disorderly Brexit or a China debt crisis.  Should any one of them materialize, it would have the potential to derail the global growth outlook to a measurable degree.

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Chinese equities: What is in store for Chinese equities in 2019?

Key takeaways

• We believe Chinese equities represent some of the best structural opportunities across global markets.
• Following the correction in 2018, we believe the risk-reward picture has turned exceptionally favorable.
• We believe corporate fundamentals will remain strong given solid support from the domestic market.

There has been a disconnect between sentiment and fundamentals when it comes to Chinese equities in 2018. Market sentiment has been weak (driven by the changing relationship with the US and moderating growth), while economic fundmentals remained decent. China was on track to deliver its growth target despite moderation, widely known as a result of economic transitioning towards high quality growth.

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Global equities: A decade after the global financial crisis, a mixed bag of growth

Key takeaways

• The overvaluation of structural growth stocks, such as technology stocks, is unsustainable, in our view.
• For markets used to easy money, the transition to a more ‘normal’ period for central banks is likely to pose a challenge.
• The European market looks a lot more attractively valued than the US, especially those stocks more sensitive to the direction of the economy, such as banks.

The outlook for global growth has become more mixed. While the synchronised economic expansion that I discussed in this piece last year is less widespread today, it should still be sufficient for corporate earnings to grow. Amid continued regime change – quantitative easing has given way to quantitative tightening, and interest rates are rising – the US continues to press ahead, while there is less momentum elsewhere.

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Putting the sell-off in perspective

Last week saw major swoons in the stock market and U.S. Treasuries. As of this writing, the sell-off has been continuing. However, I still hold out hope that we could see stocks finish higher than where they are now by year-end. Yes, Virginia, there still is the possibility of a “Santa Pause.”

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Stock losses snowball across the globe in a December sell-off

U.S. stocks began a dramatic sell-off on Tuesday that has continued and spread to other parts of the world, creating intense headlines across the globe on Thursday. There has been a flight to the perceived safety of sovereign debt. The yield on the 10-year U.S. Treasury fell dramatically, from more than 3% at the start of the week to 2.83% as of this writing¹ – and other major sovereign debt yields also followed suit. Some areas of the yield curve inverted, and the 2-year/10-year yield curve is in danger of inverting.

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Bank of Canada walks back from impending rate hike

The Bank of Canada (BoC) left the overnight rate unchanged at 1.75% at its December 5 meeting. The tone around the message softened dramatically from the previous meeting in October.

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