With the dawn of 2019 there is already a lot to consider for market positioning. The market volatility at the close of 2018 took some by surprise. We’re seeing a big shift in the global central banks’ desire to intervene or take on holdings, at a time when political risk is rising and trade war speculation continues. So how have these developments affected our outlook?
In our latest client call, Alex Wolf, Head of Investment Strategy for Asia at J.P. Morgan Private Bank, Ben Sy, Head of Fixed Income, Currencies and Commodities for Asia, along with Asia Equity Strategist Dmitri Shneider, discussed the triggers of recent volatility, the critical looming factors for 2019, along with areas of opportunity.
- Global growth is weakening as political instability and trade disputes linger
- Market pricing of Fed rate hikes suggests continued doubt about the Fed’s ability to raise rates
- U.S. markets still represent opportunity, particularly in the technology sector
- Equity investors could look to secular forces within sectors
- China could provide opportunities for 2019, but closer to the end of the first quarter
- Fixed income investors could prioritize long-term strategies
Unravelling the macro outlook
The volatility of late 2018 was caused by a variety of factors. US-China trade talks are making positive progress, but many investors appear to be waiting out the coming months. Global growth is weakening, which can be attributed to various factors, including weaker global trade, continued political risks, and tighter global liquidity. On top of this, a central narrative of recent times is that we are seeing reduced intervention from central banks.
Trading liquidity was very light in December, which can partly be attributed to the fact that many decision makers were on vacation during this period. In addition, many hedge funds have closed their books over the holidays. There was also passive selling that amplified the crisis.
Recent U.S. pullback provides a more interesting risk reward
S&P 500 has pulled back 15% from the peak, at one point it was 20%1. We have been striking a more cautious tone for 2019 in the past few months. The direction is not surprising, the magnitude is. After the recent pullback, the U.S. looks more attractive and markets have moved from pricing optimism just months ago to pessimism currently.
Year-end liquidity was light, magnifying some of the price action. Without going into too much detail: 1) tax-loss harvesting in the U.S.; 2) many decision makers that are generally willing to act as shock absorbers were on vacation; 3) many hedge funds have closed books for the year.
Pullbacks like this are not uncommon and markets generally pulling back 6-12 months ahead of recessions. We believe the 20% peak-trough feels like the market is pulling forward a lot of those recession fears that we thought would play out in 2019.
Post this pullback, we forecast 6%-10% returns in 2019, but with considerable volatility. We expect 4-6% earnings growth in 2019 and even with mild negative EPS growth in 2020, we believe there’s upside to the S&P given a below average valuation around 14.5x.
Keep sight of the secular forces
In identifying equity opportunities for 2019, we prefer U.S. on a regional basis, though now see mid-high single digit upside for most major markets globally. Within the U.S. market, we think the technology sector offers good opportunities. It was a controversial and crowded trade earlier in 2018 which has now been unwound. FAANG stocks, including Apple as well as broad tech, have been sold off recently, despite growth being reasonably stable. Valuation relative to growth are now near last cycle’s relative to the S&P 500. We are seeing sustainable earnings due to secular forces; such as the development of Artificial Intelligence (AI), Big Data and robotics.
Where to look in Asia
We believe China equities offer upside, but with better entry points likely closer to end of the first quarter as data starts to improve and more government stimulus is initiated. Volatility will remain, especially until further clarity comes regarding US-China trade talks. It remains to be seen whether the Chinese are willing to offer concessions. In the event that a resolution is found for the recent trade disputes, China could see a bounce. Beijing’s stimulus could range from infrastructure spending, personal and corporate tax cuts, and monetary easing. Indeed, China has considerable appeal to many investors due to emerging themes such as e-commerce, electric vehicles and education. The first quarter will be a vital period to monitor.
India is also an attractive option. It has performed defensively and stands out due to its secular growth drivers which have helped economic activity recover post one-off disruptions. Additionally, it is somewhat insulated if trade concerns rise from here.
Fixed income and finding neutral
For fixed income, the ‘elephant in the room’ is the increasing risk of recession in 2020. Despite U.S. economic fundamentals being strong, the Fed lowered its target for rate hikes to two for 2019, while the bond market is predicting less than one hike in 20192. There is currently a discrepancy between what the bond markets think will happen, and conversely what the Federal reserve is anticipating. We believe the Fed may hike one to two times in 2019.
There is considerable debate about the correct figure for the U.S. neutral interest rate. The neutral (or natural) rate of interest is the rate at which real GDP is growing at its trend rate, and inflation is stable. We would say that neutral is somewhere between 2.75 and 3% area, as previously indicated by the Fed3. After one more hike in December 2018 to 2.5% Fed fund rate4, we are now close to the neutral rates suggesting interest rates are near the peak of the cycle.
As interest rates are near this neutral level, the Fed’s future interest rate decision will be more economic data-dependent, rather than the dot plots previously which is based on Fed members’ economic forecast.
Consider long duration
2018 was one of the worst years for fixed income –and we don’t anticipate a repeat in 2019. However, returns will remain challenging as there are headwinds on the horizon as credit spreads may widen further. We think long-term investors may be rewarded as yields are back up to more normal levels. U.S. high yields are back up to 8% area, while investment grade bonds are already above 4.5%5. The emphasis for anyone considering this space is to look to high quality investment grade bonds, that is BBB+ or better, governments and agencies.
In currencies, we expect the dollar to weaken slightly, while in Asia, the Chinese Yuan appears challenging given that Beijing looks set to cut rates and deploy quantitative monetary easing in the coming year.
To discuss these ideas further, or to learn more about your portfolio positioning at this time, please contact your J.P. Morgan representative.
1 Bloomberg. Data ranged from September 20, 2018 to December 24, 2018. Data as of December 31, 2018.
2 Fed Fund futures, CBOT, as of December 31, 2018.
3 J.P. Morgan, Federal Reserve Board, as of December 31, 2018.
4 Federal Reserve Board, as of December 31, 2018.
5 J.P. Morgan HY bond index; JULI, as of December 31, 2018.