Tai Hui, Chief Market Strategist, Asia, J.P. Morgan Asset Management and Chris Blum, Head of Investments, Asia, J.P. Morgan Private Bank, recently explored the outlook for global markets and potential investment returns.
Conditions throughout the world economy continue to improve and growth momentum looks set to continue throughout the second half of 2018. Majority of countries currently have a Purchasing Manager’s Index of above 501, signalling healthy growth. In the US, there’s been moderate growth in the first quarter, with the economy expanding by around 2.8% year-on-year2. The macroeconomic indicators are consistent with a late cycle, but that does not mean we are approaching the end of the cycle.
Speculation around a trade war between the US and China continues. The US has announced around $50 billion worth of tariffs on Chinese imports, sparking retaliation from China3. Although President Trump is threatening further tariffs, it remains to be seen whether he may put these into action.
Additional levies on foreign goods could start to have an impact on household brands, putting pressure on both consumers and US corporates. The US is also involved in a number of trade confrontations with Europe, Canada and Mexico, where cars could become another item on the tariff list.
Negotiations between the US and China are ongoing and might yield results in the upcoming months. In the meantime, tensions are likely to continue and some market volatility is expected. It’s important to note that latest round of tariffs on Chinese imports are relatively modest, amounting to only 0.3% of China’s gross domestic product (GDP)4.
The Federal Reserve (Fed) is continuing to reduce its balance sheet and slowing down bond purchases as the global economy continues to strengthen. The US central bank is expected to gradually raise interest rates every quarter between now and the end of 2019, reaching the Fed’s neutral rate of a range of 2.75%–3%5.
However, the Fed’s move towards the normalisation of monetary policy contrasts with other central banks such as the European Central Bank (ECB) and Bank of Japan (BoJ), which are likely to keep rates low throughout 2019 and 2020.
Despite the robust global economic recovery, consumer inflation is not rising as expected in the US and other developed markets. There are secular deflationary forces contributing to this trend, including the rise in automation and the so-called “Amazon effect”, which indicates that online retailers have suppressed inflation by keeping prices low.
As a result, central banks such as the Fed are tightening monetary policy in preparation for a possible downturn in the future. Although there is a lack of inflation pressure, there is increasing pressure in terms of assets. While the Fed’s mandate is focused on consumer prices, the central bank would also be monitoring asset prices to ensure they do not inflate further due to an extended period of relatively low cost money.
The European recovery is underway but is lagging the US. While countries such as France and Germany are expanding, weak spots remain in the Eurozone. Government debt remains high, but the ECB is likely to remain cautious in the short term.
After a strong 2017, a sharp rise in bond yields in the US and a stronger dollar so far in 2018 have had a negative impact on emerging markets (EMs). Those who have suffered the most have also had domestic issues.
Despite this, the global environment is supportive and EMs are likely to benefit in the second half of 2018 as fundamentals kick back in. Asia’s contribution to global growth is well in excess of that of the US and Europe combined, amounting to around 40%6. In contrast, the US and Eurozone combined currently contribute around only 15% of global growth7.
The corporate bond market is undergoing a shift in China. There are ongoing concerns around deleveraging, and companies that borrowed when the US dollar was undervalued and interest rates low are now under pressure as the dollar strengthens while the yuan weakens. Although the default rate looks set to rise, the Chinese government has the ability to navigate the ongoing economic rebalancing in the country.
As the global growth story continues, we believe global equities might continue to deliver particularly strong returns. In regions such as the US, Asia, EMs and Europe, we continue to see expansion. The cycle has not yet reached its end and the strongest returns in equity markets have often been at the very end of a cycle before we see a recession. However, we do not foresee a recession in the next six to 12 months.
Despite recent trade war tensions and other geopolitical events, we believe it is premature to substantially de-risk and if anything, recent pushbacks have created a buying opportunity for high conviction ideas. In terms of fixed income, corporate bond spreads are still relatively narrow, but strong fundamentals both at the government level and in the developed corporate sector means default rates might remain low. With rates at the short end rising, we favour short duration strategies as yields are more attractive in the current environment. Equities are attractive as outlook is still positive and history suggests market strength at the later stage of the cycle. That said, moderating market exposure is warranted in the later stages of the economic cycle.
1 Guide to the Markets, J.P. Morgan Asset Management, data as of June 30, 2018.
2 Guide to the Markets, J.P. Morgan Asset Management, data as of June 30, 2018.
3 Reuters, as of April 3, 2018.
4 Guide to the Markets, J.P. Morgan Asset Management, data as of June 30, 2018.
5 Markets Monthly, June edition, data as of June 30, 2018.
6 Guide to the Markets, J.P. Morgan Asset Management, data as of June 30, 2018.
7 Guide to the Markets, J.P. Morgan Asset Management, data as of June 30, 2018.
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