Global growth is slowing but America remains strong
Volatility returned with a vengeance in 2018 after an unusually quiet 2017. Wall Street suffered its worst December since the Great Depression, leaving global stockmarkets lower for the year in sterling terms for the first time since 2011. UK property was a relatively bright spot, however, and diversification limited percentage losses in a typical mid-range multi-asset fund to the low single digits.
We are late in the business cycle and stockmarket volatility is likely to remain high over 2019.
It usually rises about two years after the US Federal Reserve starts to hike interest rates, so 2018 was right on cue. Markets tend to calm down again once interest rates have been cut and an economic recovery is under way, but that still feels a way off and we should get used to wide trading ranges.
Markets pricing in recession
Bull markets in equities are linked to expansion phases in the world economy. At nine and a half years and counting, this is the second-longest US expansion on record. The economic expansion has to last another six months to equal that of the record-breaking 1990s.
Market participants doubt it will make it and are pricing in a recession. They don’t always get it right though. Prices moved sideways in 2011 and dropped in 2015/16, with the economy slowing rather than stalling in both cases.
December weakness may reflect a temporary drop in activity associated with threatened tariff increases. Investors were also surprised by president Donald Trump attacking the Fed, recalling troops from Syria and triggering a government shutdown, not to mention all the Brexit-related uncertainty.
US data inconsistent with recession
Global growth has been slowing for a year or so, led by China but with European data also weakening markedly. The US economy remains relatively strong on the back of tax cuts and spending increases. Jobs are still being created and real interest rates are low.
Softening US housing market indicators are a concern as housing can be a lead indicator for the broader economy. The lags are long though. The usual relationship suggests a recession with rising unemployment going into 2020, not in early 2019.
The Fed may also be close to pausing its rate hikes as its intention is more to normalise rates than move to a restrictive monetary stance.
Stockmarket weakness tends to make central banks pause. Business confidence is also dropping and the plunge in the oil price is taking inflation out of the system.
Our proprietary Investment Clock model guides our tactical asset allocation. With recent data, particularly the sharply lower oil price, it has moved from stagflation into reflation. Interestingly, in this phase, central banks tend to cut interest rates, rather than raise them.
Growth could still surprise positively
With expectations so low, could growth surprise positively? The recent collapse in energy prices sets the scene for a strong US consumer in 2019. The oil price is a good one-year lead indicator for US consumer spending. A lower oil price partly explained the sharp upturn in growth in 2016/17.
Chinese authorities have started stimulating their economy to counter the slowdown and offset the impact of possible US tariff increases. Alongside repeatedly cutting banks’ reserve requirements, they have been quietly easing monetary policy over the past year, judging by the drop in local market bond yields.
Fiscal stimulus is also under way. Tax cuts and further stimulus are widely expected. China was the swing factor that turned a soggy 2015/16 into a strong 2017/18.
In it to win it
It usually pays to be bold when others are fearful. We start the year constructive on stocks: to borrow from Mark Twain, reports of the death of the US business expansion are exaggerated. However, we expect to become more cautious as the year progresses. There just isn’t much spare capacity in the US economy. A sharp recovery in China could lead to Fed over-tightening, raising the risk of a full-blown recession in 2020, consistent with early warnings from housing data.
Trevor Greetham is head of multi-asset at Royal London Asset Management