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Markets going back to reality in 2019 says HSBC

Joseph Little, Global Chief Strategist, HSBC Global Asset Management, shares his investment outlook for the year ahead:

  • 2018 has been a difficult year for investors
  • Fundamentals continue to look good, but macro trends are changing in 2019
  • The probability of a global recession still looks low
  • Asian and emerging market equities offer attractive value

“2018 has been a disappointing year for investors. After the stellar investment returns of 2017, perhaps it was always likely to feel this way. The good news is that, despite current pessimism about the economic cycle, the fundamentals continue to look good. But the investment themes are changing.

 

Source: HSBC Global Asset Management, November 2018.

 “The global economy is moving from cyclical divergence in 2018 to running on two engines of growth – China and the US. The outlook for these two engines will be really important for determining the path of the economy in 2019.

“The uncertainty around the Chinese macro outlook is high at present. Looser financial and monetary conditions should result in solid growth but, given the high debt levels in the corporate sector, there are concerns that monetary policy may not be as effective as in the past. The levels of debt are also a constraint on the amount of loosening the authorities will be willing to use to engineer an upturn. Having worked hard to slow the pace of debt accumulation and rein in financial risks, they will not want to move backwards by reflating the debt bubble. They are still aiming to strike a balance between maintaining growth and limiting financial threats.

“In our view, the US economy is set to slow from a strong starting point of well-above-trend growth to a more average pace by the second half of 2019, accompanied by a gradual rise in core inflation. If this outlook materialised, the Fed would probably largely follow through on its current projections of around 100bp of hikes between now and end-2019, which can best be described as a policy return to neutral rather than outright restrictive. Crucially, market pricing is closer to the Fed’s scenario than it was at the start of 2018.”

Growth at a reasonable price

“After the phase of synchronised global growth from late 2016 to early 2018, the global economy has lost some vigour. According to our global Nowcast – a real-time measure of economic activity – after being well-above trend at the start of 2018, global growth is now back to its average rate of the last five years. This is hardly a disaster, and we think the probability of recession still looks low, but it does mean that, as we approach 2019, the economic system is moving ‘back to reality’.

“Where valuations remain sound, there is an opportunity to go ‘back growth at a reasonable price’. We prefer to do this through global equities rather than global credits, although we think that credits have become a bit more attractive. For us, current valuations imply that we should now focus our tactical risk budget on Asian and emerging market equities. In multi-asset portfolios, we also think there is value in some US Treasuries, especially compared to European government bonds.”

Is safety “safe”?

“Conventional notions of safety have not worked this year. Of the main asset classes, only US equities and the US dollar have recorded gains in 2018. Other asset classes are either flat or have delivered negative returns. Even traditional diversifiers performed poorly, meaning typical sources of portfolio protection were ineffective.

“We have seen a significant re-pricing of US fixed income assets this year. Our measure of the US ‘bond risk premium’ – the future reward for owning bonds over cash – has increased during the year and is now slightly positive, while we think short-duration US bonds now offer attractive risk-adjusted prospective returns. Outside of the US, the risk premium on global government bonds remains very negative.

“From an asset allocation perspective, our portfolios should reflect this shift in the market odds. On balance, we are still inclined to be underweight duration on a global basis, but relative to our position last year, our overall portfolio duration should increase. In global rates, we have a preference for US treasuries, and we favour the short-end and the belly of the curve. Perhaps our clearest current preference is for a relative-value trade between more attractive US Treasuries and very expensive German Bunds.”

“It is worth noting that risks remain, for example if inflation trends build or if the market starts expecting stronger inflation. That’s not what we expect, but we need to monitor that scenario closely and we certainly can’t rule it out.”

The importance of portfolio resilience

“Macro and political issues will likely have a significant impact on market action going forward. In this tricky environment, investors need to build portfolio resilience.

“Looking at short-duration parts of US rates and US credits in particular, we find that many traditionally perceived safe haven asset classes are now offering much better carry than in previous years. This shift in pricing allows us to build portfolio resilience by adding some shock absorbing and diversifying fixed income asset classes to our multi-asset portfolios: we think this is a good hedge in case the macro landscape evolves less favourably than we expect.”

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