Our macro views:
- The global expansion continues but the US slows
- Effects of US stimulus will fade and monetary policy tightening will also ease
- Chinese growth is likely to stabilize by mid-2019, supporting the emerging markets block and Europe
If 2017 was about synchronized global expansion and 2018 was about the divergence of United States growth and policy away from the rest of the world’s, then 2019 will likely be about convergence, as the US slows to a pace more in line with the global expansion. This slowdown in US growth, paradoxically, will be a positive development for equities globally.
2018 brought equity and credit market struggles, but this volatility was not about a sea change in macroeconomic fundamentals. Rather, the volatility was more about investors buying the rumor of late-cycle fiscal stimulus and heightened expectations for economic activity and earnings growth, only to sell the news when stronger short-term growth brought forward tighter financial conditions. In the end, the US got better growth but bad policy (Fed tightening and tariffs), and market returns suffered globally.
The US economy is no longer accelerating, the result of tightening by the US Federal Reserve, higher interest rates across the yield curve, and a persistently strong dollar. Rate-sensitive sectors, such as housing and automobiles, are slowing. US economic growth will likely slow in the first half of 2019 and weaken further in the second half but remain at or above trend.
For 2019, the upshot is an environment where US growth is slower but policy is better, the exact opposite of 2018. As US growth decelerates to 2%, so too will interest rates fall and inflation moderate, alleviating pressures on the Fed to tighten further. A recession, with that backdrop, is unlikely. If anything, slower growth but better policy will extend the elongated US business and market cycle indefinitely.
Before getting too optimistic, we should caution that this “Goldilocks” environment for rates and inflation does not necessarily apply across the globe. Fortunately, we see a possibility of growth stabilizing both in the emerging markets and Europe by the second half of the year. However, that scenario will be dependent on the restrained stimulus measures in China gaining traction and on a more-favorable trade environment between the US and China. A further deterioration in US and China trade relations, while not our base case, looms as a non-trivial risk to global growth and international assets. Emerging market asset valuations remain the most attractive globally, though a catalyst is necessary for current circumstances to change. A trade agreement coupled with lowered US growth expectations could be the catalyst.
Investors, until the end of this cycle, are likely to favor quality companies that can demonstrate true earnings growth in a persistently slow growth environment. The dispersion of returns among those companies, however, will be higher as earnings growth peaks and profit margins narrow. Security selection will become even more critically important. Fixed income investors across most sectors should expect coupon-level returns, at best.
In the meantime, we will continue looking out for telltale signs indicating the end of the current cycle, even as we believe none of them are forthcoming.
Proceed with caution if…
We think slowing global growth, coupled with lower rates and decelerating inflation, will likely sustain the cycle and improve the equity market environment. Get used to it. This will go on for five more years.
Read the 2019 Outlook for our complete views on the global economy and markets.
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