In our 2018 Point of Focus, we highlighted several key factors that caused us to stress caution for 2018. The continued rise in asset class valuations while disconnecting the underlying risk caused by geopolitical tension had the predicted outcome as markets fell in the last quarter. Too much liquidity was flowing to a limited set of asset classes in an effort to diversify risk away and replace low yielding government securities.
2019 will be a transitional year. Underlying fundamentals will continue to drive global growth, albeit at a slower pace, with valuations reflecting this adjustment in reality. We do not predict a recession, but a return to sanity as growth comes at a cost as we depart from the historic decade of nil level interest rates. Markets will become increasingly volatile in the mid term as it adjusts to the new equilibriums. There are several points we want to draw attention to in the coming year that will contribute to market movement:
Geopolitics will be at the forefront this year. Despite a modicum of volatility in recent, markets have largely shrugged off the growing bouts of political tension arising across the globe. The longer term implications of populist policies are beginning to take hold to a level that investors can no longer turn a blind eye to. In 2019, elections in Europe, India, Argentina coupled with policy movements in China and the developing markets will cause greater uncertainty towards the international order of trade that has dominated global norms in past decades. The current destabilization of the US and UK political systems will continue to contribute to volatility moving forward this year.
Equity valuations remain a concern even after the most recent retracement as they are still trading at the high end of historical ranges. Risk premiums for debt are still low, and property prices globally are still unaffordable for the average person. These factors point to the beginning of a potential devaluation cycle.
China’s economy is wading through a trade war slowdown as well as a government sponsored deleveraging. We remain cautiously optimistic that the Chinese government will be able to keep tight controls and navigate these perils; however there will be winners and losers. Fortunately, they have been consistent in telegraphing which industries will come under pressure and which industries they will support.
Emerging markets suffered the most in 2018 as investors fled to safety in developed markets, depressing valuations to historic lows. As volatility continues, there will be opportunities to invest in the next set of global growth engines at bargain prices. But focus will have to be sighted on a combination of true fundamentals and a calculation of underlying political and economic risks.