The IMF confirmed this view in January, revising its global growth forecast down to 3.5 percent from 3.7 percent. Its U.S. growth prediction held at 2.5 percent, while the outlook for 19 nations that use the euro declined from 1.8 percent to 1.6 percent. Other analysts predict even lower numbers in the Eurozone — 1.4 percent in 2019 and 1.2 percent in 2020 — as well as slower growth in China of 6.1 percent due to the impact of U.S. tariffs.
Bright spots
This doesn’t mean the buy side will not be able to find good opportunities. According to State Street Global Advisors, U.S. equities are a potential bright spot. One factor that could increase their value is the results of the 2018 mid-terms. With Democrats in control of the House of Representatives, there is greater potential for infrastructure spending. Another factor is strong earnings growth for U.S. companies. One downside risk is increased rate hikes, but the Federal Reserve recently reduced its forecast to two key interest rate hikes in 2019 instead of three.
“We don’t see evidence the U.S. bull market is about to end,” says Richard Turnill, managing director, global chief investment strategist, BlackRock. “All our economic signals suggest above-trend growth in the U.S. over the next 12 months.”
Turnill notes three events that could trigger the end. One is traditional overheating, with accelerated inflation and the Fed stepping in to “stamp on the brakes.” The second is escalation of the trade war with China. The third is financial risk, or a bubble, caused by excesses within financial markets. But he sees little evidence of these.
“We’ve seen a series of volatility spikes through 2018 starting with bitcoin and extending to tech and emerging markets,” he says. “But the market rolls on. We don’t see conditions for the end of a bull market. But uncertainty is increasing. You want to have equities but focus on areas that are most resilient.”
Peaks and curves
After a difficult year, the fixed income market looks to continue moving toward the end of the credit cycle. In the U.S., rates are close to a cyclical peak and the yield curve is expected to flatten. Other countries are lagging behind simply because the U.S. began its recovery earlier. Further, structural constraints on U.S. growth and inflation — rising debt levels, an aging population and low productivity — will provide a cap on real rates according to State Street Global Advisors.
“There are a few factors in the U.S. that could drive 10-year treasury yields higher,” says Karen Ward, managing director and chief market strategist, EMEA, for J.P. Morgan Asset Management. “As people’s expectations about the distribution of inflation normalize, that will push term premium higher. If we see a resurgence in productivity in the U.S., that will drive the rate up as well. To see 4 percent, however, we need to see normalization elsewhere in the world.”
Investors seem relatively complacent. Perhaps because, in recent years, political risks haven’t had much impact on markets. This disconnect between global economic performance and dire politics in advanced economies is an alarm signal, according to Tina Fordham, managing director and chief global political analyst for Citi.
“As we enter a period of tightening in central bank policy with concerns about inflation and reasonably good growth, political risks will start to register more than in the past,” she says. “If you’ve been trading the last eight years, you could be forgiven for thinking political risks don’t matter. But quantitative easing has masked these risks.”
A crossroads for Europe
One of the biggest political risks is the seemingly never-ending uncertainty over Brexit. In the first quarter of 2019, U.K. Prime Minister Theresa May’s withdrawal deal was defeated in parliament three times by astonishing margins. With confidence faltering in May’s ability to deliver Brexit in any form, MPs took matters into their own hands through a series of votes to establish alternative courses of action – none of which gained a clear consensus.
In a bid to avoid the catastrophic “no deal” scenario that many fear, but no agreement on how to avoid it, May sought an extension to Article 50, then another. At the time of writing, the latest date for the U.K. to leave the EU was set at 31 October. May had opened up talks with the opposition Labour party in an attempt to agree a compromise deal that could pass through parliament. And Conservative cabinet members were lining up to challenge her leadership.
We are no closer to knowing how the U.K. will leave — whether under May’s deal, with a “softer” deal or with no deal at all — or, indeed, if it will leave at all, with many backing a second referendum or general election as the only way to break the deadlock.
The grinding uncertainty is prolonging the pain for the U.K. economy, with businesses and consumers on edge and investment intentions at their lowest level for eight years. That’s why news of the delay was welcomed with gritted teeth — more instability, without a guarantee of a better conclusion, is only marginally more appealing than a hard Brexit.
The six-month extension is seen by the Bank of England as too short to lift uncertainty for businesses and consumers, so it is unlikely to raise interest rates. In response to the delay announcement, the IMF cut its prediction for 2019 to growth of 1.2 percent from 1.5 percent — and even that is based on the assumption that the government will secure a deal.
“We have reached a nadir of negativity,” says Michele Gesualdi, Chief Investment Officer for Kairos Investment Management. “If you look at sterling and rates, there is a Brexit premium already built into these assets. Sterling is 20 to 30 percent cheaper than it should be in a normal scenario. If you look at rates, even more so. Clearly, the MPC wants to raise rates but is looking for a deal to do that.”
Despite MPs backing a move to prevent it, “no deal” remains the default legal position and the biggest danger on the horizon. The Bank of England has warned that the economy could shrink by 8 percent within a year, property prices could plunge almost a third and the pound could loses a quarter of its value.
Counting the cost
However — and whenever — the U.K. leaves, the Brexit vote has already caused considerable damage to the economy. There has been a steady departure of money and jobs from the City of London, which looks set to continue; without single-market access, U.K. banks will be subject to equivalence decisions like any other non-EU country. The housing market is down. A dramatic drop in immigration has left the hospitality, agriculture, construction and health industries grappling for workers. And the U.K.’s status as the European hub of choice is under threat.
With more months of limbo ahead, questions about everything from trade policy to immigration laws are choking hiring and investment decisions. Companies are spending millions of pounds on contingency measures and plotting overseas moves, while global banks are moving operations, assets and people to other European cities.
There is a domino effect. Global businesses that rely on the U.K. for trade and talent are on edge. Asian companies, who will face higher tariffs and costs post-Brexit, are forced to consider cutting their workforce and moving head offices out of the U.K.
However, there have been moments of optimism amidst all the uncertainty. The round rejection of May’s initial deal led to a stabilization of the pound in response to a perceived increase in the likelihood of a softer Brexit — or of none at all, which investors would welcome. “This outcome is so dire for Brexit that the chances of a softer Brexit or even a second referendum may have risen,” said Stephen Jen, chief executive of Eurizon SLJ Capital, at the time.
Time is running out for May’s government to agree on an exit strategy that will satisfy both voters and the markets. The situation is changing by the day. As with the U.S. and China trade war, caution is warranted as we progress into 2019; we can only hope for an end to some of the uncertainty.