The difference between 2017 and 2018 was due to a regime shift that goes beyond the cyclical nature of asset markets. Indeed, for the first time in more than 30 years, it seems as if bond yields have started to rise for good. This change in regime confronts an investor community that has never had to deal with structurally rising rates in their careers. The last time bond markets went from deflation to reflation was, in fact, back in the 1950s.
The last official US recession was in 2009 and investors are wondering how much life is left in the current cycle. Looking at the growth/inflation dynamics, we think 2019 will prove to be a solid year for growth, with some upside risks to inflation rates.
Growth topping and inflation rising – is this stagflation in the making? The answer is no, stagflation - the combination of high unemployment and high inflation - is quite a different animal. With more than 3.5 per cent growth and 'only' 3.5 per cent inflation expected in 2019, the global economy could not be further away from the stagflation misery that haunted it back in the 1970s. Yet it is a typical late-cycle environment. Looking at the longer-term picture, we deem the current environment to be rather like the 1950s, when rates rose only moderately.
However, given the fact the global economy has normalised, monetary policy will most likely normalise too. This is true of the US Federal Reserve, which started the process two years ago. It should bring target rates (again) to 3.5 per cent or so. In 2019, other major central banks may follow suit.
The European Central Bank is expected to terminate its asset purchase programme by the end of the year. Given the economic backdrop and still subdued inflationary pressures, an interest-rate hike is rather unlikely in the first half of 2019. Interest-rate normalisation would, however, be positive for European equities. The Bank of Japan has started to adapt its rhetoric and will likely continue to do so in the quarters ahead.
For investors, this means that monetary policy support, which has been one of the major tailwinds in the investment world, is fading. Investors ought to bear this crucial factor in mind going forward.
With regard to the political noise ahead, the ‘ceasefire’ in the US–China trade conflict is short-term positive for global equity markets. However, it remains to be seen whether the two countries are able to solve the thorny issues to be discussed in the next three months. In view of the ongoing geopolitical rivalry, the risk remains that the ‘ceasefire’ will prove to be only temporary. The trade conflict and other political market movers such as Italian Politics and Brexit will remain wild cards.
Looking at global government bonds, we believe they will remain vulnerable. We continue to prefer selected exposure in the credit segment. Emerging markets hard-currency corporate bonds are particularly attractive given the moderate leverage of the underlying corporates and the relatively attractive credit spreads.
The continued rise in the cost of capital will maintain pressure on highly leveraged assets and market segments.
What matters for your portfolio in 2019? We believe these four topics are set to remain relevant throughout 2019:
1. Adapt your portfolio as interest rates rise
Developed market equities continue to drive portfolio performance:
• Growth in the developed world remains robust and the economic cycle is not yet coming to an end.
• Yields are set to rise further as inflation kicks in.
2. Capture Next Generation trends in your portfolio
Digital disruption – from IT to mainstream:
• Digital innovation is reshaping all industries.
• The recent correction provides interesting entry points into some of the most exciting themes.
3. Find a store of value
Swiss equities are hard to beat:
• With political and market risks on the rise, diversification is increasingly important.
• Swiss equities have proved to be a store of value time and again.
4. Navigate financial markets
2019 is set to be a year for active investing:
• Increased volatility is here to stay.
• Investors not able or willing to follow the market closely should rely on actively managed solutions.
Christian Gattiker is the head of research and investment solutions at Julius Baer