The key market challenges for 2019

Summary: A combination of global economic events and geopolitical uncertainty remain on the agenda for 2019.

Key take-out: Equity markets will present both opportunities and threats for investors.

What’s in store for investors in 2019? We’ve spoken to 20 of Australia’s leading fund managers to get their views on the year ahead, opening with the question: What do you see as the main challenge for markets in 2019?

Last year, there were five wild trading sessions when the US stock market swung by more than 1,000 points. Four of them were in February, including the biggest fall in history when the Dow Jones index dropped 1,175 points on February 5, heralding the return of global markets volatility after a long period of relative calm.

Then, after a series of heavy market falls in recent weeks, the US market recorded its biggest ever single-day rise on Boxing Day, gaining 5 per cent with a spectacular 1,086 point rise. The Australian market has been far less impressive to date.

Below are a wide range of views from Chief Investment Officers, senior portfolio managers and investment managers, on what they see eventuating over the year ahead.

In tomorrow’s instalment, the same fund managers will reveal where they see the growth opportunities in 2019, and in a third article, they will outline their strategic advice to investors on how to handle the next 12 months.

Jacob Mitchell, Founder and Chief Investment Officer, Antipodes Partners

Will volatility normalise, or increase into 2019? In the US, against a backdrop of relatively subdued inflation, growth is soaring, with Trump’s domestic policy analogous to burning all the furniture in the room. While some indicators, such as the corporate profit cycle, industrial production, unemployment and consumer confidence suggest the economic cycle is maturing, residential/corporate investment and wage inflation is still at early or mid-cycle levels. The risk to the cycle is monetary policy, with an increasingly limited fiscal backstop.

David Macri, Chief Investment Officer at Australian Ethical Investment

The main challenge is whether the US economy can navigate through a period of rising interest rates without hampering growth. The recent volatility in markets and inversion in parts of the yield curve in the US suggest that investors are becoming concerned amid the backdrop of US trade tensions with China – despite the US economy performing well given strong consumer spending, strong PMIs and growing corporate profits. Additionally, we see a potential risk to corporate margins arising from a tight labour market.

Julian Beaumont, Investment Director, Bennelong Funds Management

The main challenge for markets will be a tightening of global liquidity. By the start of 2019, central banks will in aggregate have become net sellers of assets, and central banks are eager to normalise rates higher. This quantitative tightening is unprecedented, and provides genuine uncertainty. All asset markets face real risks as a result of this. And as we saw in October of 2018, markets are shooting first and asking questions later.

Scott Kelly, Portfolio Manager, Income Portfolio, DNR Capital

Macroeconomic and geopolitical risks remain challenging to predict (in particular trade wars, China growth outlook, US recession potential, Brexit scenarios and Australian housing downturn). The global economy has slowed in the face of these factors over the past six months, leading to the potential inversion of the yield curve. A negative yield curve means bond investors are expecting a slowing economy, and historically it has often, but not always, been a leading indicator of recession.

Stephen Miller, Investment Adviser, Grant Samuel Funds Management

Globally the major challenge for markets in 2019 is managing the fallout from further Fed tightening (albeit at a reduced rate) and a slowing US economy (albeit to something around trend), a slowing Chinese economy and only tepid growth elsewhere in the world. US bond yields are likely to edge higher as the Fed tightens while reducing its balance sheet and the bond selling task associated with a large budget deficit continues to weigh. However, yields will be capped by slowing growth. Such a scenario implies a continuation of some headwinds for global equities. Probably accentuating the challenging environment for global equities will be geopolitical risks, particularly in Europe associated with the fissuring of the liberal / social democratic consensus to left / right extremes and also the lack of clarity around any resolution of the US / China trade dispute and a revival of protectionist proclivities elsewhere. Locally, the headwinds to growth are also increasing. A likely change of government complicates the picture. Combined with global influences this is likely to weigh on local equities.

Mark Arnold and Jason Orthman, Chief Investment Officer and Deputy CIO, Hyperion Asset Management

We expect interest rates and inflation may continue to rise over the next 12 months due to strong current rates of growth in the US economy and an associated tight labour market. However, we expect economic growth to moderate over the medium to long term, and for interest rates and inflation to remain at relatively low levels over the next decade.

Nathan Bell, Senior Portfolio Manager, InvestSMART Group

The main challenge for markets this year is navigating the slow (so far) deflation of the global credit bubble via quantitative tightening in the US, less quantitative easing in Europe, and increasing US interest rates. The repercussions started at the periphery of the global economic system with emerging markets, and is gradually moving to the core, with investors fleeing China and then Europe. The US and Australia have largely been immune so far, but along with falling house prices I expect price-to-earnings ratios to fall and more profit downgrades as interest rates increase in 2019.

Christian Obrist, Head of iShares, Australia

Markets are vulnerable to fears that a downturn is near, even as we see the actual risk of a US recession as low in 2019. Trade frictions and a US-China battle for supremacy in the tech sector loom over markets and the outlook for Europe remains tenuous as political risks in the medium term are set against a weak growth backdrop. 2019 will also be the year where we could see QE turn conclusively into QT, with the possibility of the BoE, BOJ and ECB all shrinking balance sheets along with the Federal Reserve. An economic framework of G4 central bank tightening with slowing global growth, and drastically lower EPS growth in the US will be a challenge, but the question becomes ‘how much of this is priced in given the recent de-rating we have seen in equity markets?’

Jay Sivapalan, Co-Head of Australian Fixed Interest, Janus Henderson

The key risk that needs to be watched and managed is interest rate risk, or more specifically, duration in a rising rate environment. In the case of Australian fixed interest, whilst we think this risk is relatively low given the RBA is likely to be on hold over 2019 at a cash rate of 1.5 per cent, Australian bond yields can lift in the short term on the back rising US yields. This creates for us both a risk that needs to be managed, but also great opportunities to add duration to capture higher yields that may not ultimately be sustained in markets.

Aaron Binsted, Portfolio Manager, Lazard Asset Management

We see the challenge for markets as being twofold. Firstly, the high level of starting valuations in some areas of the market and secondly, the domestic economy, particularly the cooling residential property market.

We believe this trend still may have a long way to run. History suggests that if house price declines cause consumers to reduce spending that this can happen relatively early in the price decline trajectory. The question as to whether there will be a material shock to confidence and spending that can set off a recessionary feedback cycle is more difficult to answer, but the probability of this “fat tail” outcome has clearly risen significantly as house prices have begun to fall.

Reece Birtles, Chief Investment Officer, Martin Currie Australia

We believe the key issue for global markets is the sustainability of global profit growth in the current environment where global economic indicators have recently diverged, the US Federal Reserve is tightening monetary policy and trade tensions between the US and China are escalating.

Nick Griffin, Head of Investments, Munro Partners

Our primary macro concern into 2019 is a US Fed that appears too tight and somewhat backed into a corner by its own previous rhetoric. This has come at a time when trade tensions between the US and China are sapping business and investor confidence. We now look for signs that the Fed can back off its hawkish stance without spooking financial markets and engineer a ‘soft landing’ for the US economy in 2019-2020. If this can be achieved, and with the US S&P 500 Index trading at 15x forward PE, we expect markets to eventually stabilise.

Will Low, Head of Global Equities, Nikko Asset Management

US Monetary policy. Limited interest rate hikes are already having a reasonably pronounced effect on mortgage rates and likely consumer spending. Could this lock in much slower growth (even without further hikes) – especially as the beneficial impact of fiscal stimulus rolls off? Similarly, any meaningful reduction in the supply of US dollars as the Fed slims down its bloated post-GFC balance sheet could mean more pain for some of the US’s GEM trading partners.

Europe. Will the region’s politicians continue to do a good job of undermining corporate and consumer confidence? Italy and Brexit have been garnering all of the headlines (with a sprinkling lately from Germany and France). Could these tensions escalate next year (exacerbated by trade issues / disunity over dealing with an increasingly assertive Russia)?

China. Deleveraging is giving way to stimulus. Will this work (again) or would another burst of credit-fuelled infrastructure spending undermine long-term confidence in the economy?

George Latham, Chief Investment Officer, Pengana WHEB Sustainable Impact Fund

Experience has shown that the most concerning factors are generally already priced into valuations and it is the unexpected variants of these factors, or even the completely unexpected challenges, that are not priced in and accordingly cause the most destabilisation. One of the primary areas in which we seek opportunities may be a key exception. We believe that there is sufficient denial of the inexorable rise in the costs of climate-related disasters for the economic effects to have not been incorporated into pricing expectations. This accordingly has the potential to cause significant destabilisation. In 2019 these impacts will likely be more regional than global, but the long term costs of climate change, which are already evident in 2018, will become more obviously so in 2019.

Paul Moore, Chief Investment Officer and Portfolio Manager, PM Capital

The main challenge in 2019 will be to forecast how much liquidity will come out of the market with both official US interest rates and market rates rising. Stocks have seen big updrafts and downdrafts in 2018 and we are likely to see them again in 2019. To us, this kind of volatility shows we’re somewhere in the last quarter of the game, but the question remains whether we’re at the start of the last quarter of the turbulence, or at the end of the last quarter and we’ve set the foundations for better performances.

Dr Bob Baur, Chief Global Economist at Principal Global Investors

2019 will likely be characterised by a continuation of the current dichotomy between the real economy, which is doing just fine, and financial markets, which remain in turmoil. In short: economies prosper; financial markets struggle. The world economy has vastly improved from the years prior to 2017; so, the ultra-accommodative monetary policy is reversing. Global growth is robust and will remain so in 2019. The ocean of liquidity provided during and after the global financial crisis is being withdrawn. As long-term interest rates rise, central banks raise official rates, bond purchases reverse and liquidity tightens, and financial markets will remain in turmoil. A moderate equity bear market is possible in 2019 as interest rates adjust to normal levels.

Beverley Morris, Director, Rates & Inflation, QIC Global Liquid Strategies

The ‘goldilocks’ environment of the past few years is making way to an inherently more volatile environment in 2019. The combination of slower growth, the removal of central bank liquidity along with heightened geopolitical risks most likely means a bumpier ride for most asset classes. Unresolved tariff tensions will perpetuate markets’ fear that an expected slowdown in growth towards a soft-landing, has downside risks and brings the risk of recession into focus given the longevity of the cycle. In this environment, investors are rightly demanding higher risk premia.

Peter Wilmshurst, Portfolio Manager, Templeton Global Growth Fund

US companies had a strong run in earnings and revenue growth during 2018, with numbers largely surprising on the upside. A run like that looks unlikely in 2019, and companies are already signalling that they may not be able to demonstrate the same performance next year. As the benefits of substantial fiscal stimulus from US tax cuts and greater public spending wane, these earnings and the broader global economy may have a hard time keeping pace with 2018 levels.

Jun Bei Liu, portfolio manager, Tribeca Investment Partners

Geopolitical risks and slowing global growth will be the key theme for 2019. Equity market will have to navigate the prolonged trade negotiation between the US and China, re-live the possibility of another Brexit referendum and volatile short-term oil prices. There is no guarantee that there won’t be another geopolitical shock with the experience of 2018. Investors can take comfort however that most of the uncertainties have been priced in to some extent by the equity market so far.

There is no doubt global growth is slowing at a time when central banks around the world are pulling back the liquidity supply to raise real interest rates. It’s important to note that despite the escalation in rates particularly by the Fed in the US, the real interest rate continue to be very close to zero which means there is enough support for further economic activities.

The key challenge at this point is our own economy. The risks are rising with the sharp fall in the housing market and flow-on impact to our economic activity. Strong terms of trade and infrastructure activity will cushion the slowdown, but election and policy uncertainty will overhang business activities. Without pickup in wages growth, we see downside to our economic forecasts.

Jonathan Baird, Investment Specialist, Western Asset Management

Global growth divergence, political uncertainty in Europe, trade negotiations and a hawkish Fed weighed on equities, credit and government bond markets alike during 2018. While we have made some ground recently, much remains outstanding as we move into 2019 and they will continue to move markets. Domestically, outcomes from the Royal Commission and implications of a tightening of credit standards must also be navigated in the coming year.