Review of 2018, outlook for 2019
2018: A lot weaker than expected
After the relatively low volatility and solid returns of 2017, the past year has seen almost the complete opposite with high volatility and poor returns. It started strongly in January but started to get messy from February.
At a big picture level things were fine: global growth looks to have held solid at around 3.7%, inflation rose in the US but only to target and it remained low elsewhere, the Fed raised interest rates but rates generally remain low and profits rose solidly.
But it was the risks below the surface that came together to give a rough ride. There were five big negatives:
Australia saw growth around trend and made it through 27 years without a recession, as infrastructure spending, improving business investment and strong exports helped support growth and this in turn drove strong employment growth, a fall in unemployment and the Federal budget closer to a surplus.
Against this though credit conditions tightened significantly with the Royal Commission adding to regulatory pressure on the banks, house prices fell, wages growth edged up but remained weak and inflation remained below target, all of which saw the RBA leave rates on hold.
Overall this drove a volatile and messy investment environment.
2019: Better, but volatility to remain high
In a big picture sense, the global economy looks to be going through a mini slowdown like we saw around 2011-12 and 2015-16. This is most evident in business conditions indicators that have slowed but remain okay.
Like then, this has not been good for listed risk assets like shares but it’s unlikely to be signalling the start of a recession, baring a major external shock. Monetary conditions have tightened globally but they are far from tight unlike prior to the GFC and the normal excesses in the form of high inflation, rapid growth in debt or excessive investment that precede recessions in the US or globally are absent.
In fact, to the extent that the softening in growth now underway takes pressure off inflation and results in easier monetary conditions than would otherwise have been the case, it’s likely to extend the cycle ie; delay the next recession. The slump in oil prices is a key example of this in that it will take some pressure off inflation and provide a boost to consumer spending. Against this background the key global themes for the year ahead are likely to be:
Global growth to stabilise and then resynchronise
Global growth is likely to average around 3.5% which is down from 2018 but this is likely to mask slower growth in the first half of the year ahead of some improvement in the second half as China provides a bit more policy stimulus, the Fed pauses in raising interest rates, the fall in currencies against the $US dollar provides a boost to growth outside the US and trade war fears settle down (hopefully). Overall, this should support reasonable global profit growth.
Global inflation to remain low
With growth dipping back to around or just below trend in the short term and commodity prices down inflation is likely to remain low. The US remains most at risk of higher inflation due to its tight labour market, but various business surveys suggest that US inflation may have peaked for now at around 2%.
Monetary policy to remain relatively easy
The Fed is likely to have a pause on rate hikes during the first half and maybe hike only twice in 2019 as it gets into the zone that it regards as neutral. Rate hikes from other central banks are a long way away. In fact, further monetary easing is likely in China and the European Central Bank may provide more cheap funding to its banks.
Geopolitical risk will remain high causing bouts of volatility
The main focus is likely to remain on the US/China relationship and trade will likely be the big one. While Trump is likely to want to find a solution on the trade front before tariffs impact the US economy significantly and threaten his re-election in 2020, it’s not clear that this will occur before the March 1 deadline from the Trump/Xi meeting in Buenos Aires so expect more volatility on this issue. Wider issues including the South China Sea could also flare up along with negotiations around Italy’s budget.
In Australia, strength in infrastructure spending, business investment and export values will help keep the economy growing but it’s likely to be constrained to around 2.5-3% by the housing downturn and a negative wealth effect on consumer spending from falling house prices. This in turn will keep wages growth slow and inflation below target for longer. Against this backdrop the RBA is expected to cut the official cash rate to 1% with two cuts in the second half of 2019.
Implications for investors
With uncertainty likely to remain high around US interest rates, trade and growth, volatility is likely to remain high in 2019 but ultimately reasonable global growth and still easy global monetary policy should drive stronger overall returns than in 2018:
What to watch?
After the turmoil of 2018, the outlook for 2019 comes with greater than normal uncertainty. The main things to keep an eye on in 2019 are as follows:
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