#Market Strategy — 14.01.2019

Investment Outlook 2019: Is it Late Cycle or End of the Cycle? That is the question!

Prashant Bhayani

2018 was a year of extremes

It kicked off with a bang on expectations that synchronized growth experienced in 2017 would continue. However, concerns over global growth grew and investors shifted to profit taking and a risk-off mode.

The US and China trade tensions quickly escalated after a few rounds of tariffs. Geo-political issues shrouded Europe and dampened the economic outlook. In addition, the Federal Reserve raised rates four times tightening financial conditions.

Towards the end of 2018, almost all of the asset classes were in negative territory. This is unsurprising given the amount of negative news that has been priced in globally.

In fact, the returns across asset classes were virtually a mirror image of 2017’s (Chart 1).

Asset class performance 2018 vs 2017


Source: BNP Paribas Wealth Management, Bloomberg, 7 Jan 2019

10 investment themes for 2019 - watch the video 

Some crucial questions for investors now

·         Is the U.S. late in the cycle? Or at the end of the cycle?

·         On top of trade tensions, will China experience a bigger than expected slowdown because of the domestic deleveraging and social reforms?

We believe at this point the US is in the late cycle, but not the end of the cycle

Overall global economic growth will likely remain above 3%, which is definitely not in the recession territory yet.

However, we expect a synchronised economic slowdown in the US, Europe, and Japan. Emerging Markets could then see their growth differentials expand relative to developed markets. For example, growth could accelerate in Brazil (from 1.3% in 2018e to 3.0% in 2019e) and in India (from 7.4% in 2018e to 7.6% in 2019e).

While we expect two additional rate hikes by the Fed in 2019, there is a scenario, though not our base case, where the monetary policy tightening may ease as a more cautious strategy could be adopted given that the US economy is approaching the peak of the cycle.

This was recently confirmed by the “patient” Fed Chair Powell who has become more data dependent and signaled a temporary pause.

Another positive factor is that trade tensions are thawing somewhat and could lessen as the year progresses. Finally, real rates remain low after inflation. However, high volatility will likely remain throughout 2019 and investors need to react and adapt accordingly.

In our estimation, the probability of a recession in 2019 is clearly rising, but nonetheless, not at a critical level (Chart 2). We will be closely monitoring this going forward.

Recession Probabilities


Source: BNP Paribas Wealth Management, Bloomberg, 27 Dec 2018

Chinese Government is now applying targeted fiscal and monetary policies to ease the pain of the slowdown

If it is required, depending on the trade tensions, fiscal stimulus could be up to 2% of GDP. In addition, the currency is stable, unlike the prior volatility episodes, and capital outflows remain contained.

How could investors navigate in this environment?

On one hand, investors should invest in strategies that cope with higher volatility; while on the other hand, the volatility creates good entry points for investments in multi-year Asian themes and megatrends. BNP Paribas Wealth Management has published the 10 Investment Themes for 2019, which could help investors to find their directions.

  • Themes 1 & 2: focus on reducing exposure to volatility and equipping investment portfolios with defensive quality assets
  • Themes 3 & 4:  “Internationalisation of China’s Financial Markets” and spillover effects of “International Trade Tensions” seek opportunities within selected parts of the deeply discounted Asian bond and equity markets.
  • Themes 5 – 9: focus on megatrends that will drive secular growth on a multi-year basis. It is important to utilize volatility as our friend. We would gradually add to these themes when market opportunities reveal.
  • Theme 10: covers the importance of dollar diversification via attractive Emerging Market currency carry in 2019.
Investment Themes 2019 at a glance

Investment Themes 2019 at a glance

Perhaps investors have been discounting a downturn too early. This in turn presents opportunities in equity markets that have been heavily penalized.

In addition, dollar yields are materially higher at the short end of the curve, creating attractive income potential for fixed income for the first time since the financial crisis. Finally, we expect the dollar to weaken due to slower growth and higher deficits. All these represent new opportunities for investors in 2019.

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