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Traders work on the floor of the New York Stock Exchange on December 7. Photo: Bloomberg
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

A recession is looming, easy money is ending and the yuan is falling – get set for 2019, the year of living dangerously

  • David Brown says that with indicators turning negative and austerity the norm, investors may be well-advised to liquidate and remember that cash is king

We are fast approaching that critical time of the year when investors must place their bets for 2019. It will be no easy task as investors face a battery of negative forces, adverse headwinds and a sense that the world is sinking into complete confusion. As if investors have not already been through enough hell and high water in the past decade, there is a prevailing sense that things are about to go pear-shaped again.

As markets become more focused on capital protection and risk aversion, investors will need to find better refuge. Next year will be a very tough one to stick your neck out for risk. 
The seeds have already been sown for the next recession and the world seems oblivious. Stocks are priced way too high, risk and volatility are understated and safe haven trades are still mainly parked in neutral. World trade troubles, the threat of a US government shutdown, Brexit risks, euro uncertainties, the end of policy super-stimulus and emerging market debt worries – the list becomes endless. It is all helping a deeper gloom take root.
Over the past decade, central banks have fuelled a heady boom in share values and property prices by slashing interest rates and pumping up the global economy with virtually free money under the banner of quantitative easing. Now the party is over and investors have to face the music of much less certain times and greater financial attrition.

There is still a vestige of thinking that things will be all right on the night with investors holding on for now. Asset allocation polls show no sense of endemic panic yet, but it is simply putting off the obvious. Economic confidence is slipping towards negative territory, world trade is slowing to a crawl and global policy is heading in the wrong direction.

Increased austerity and the shift to higher interest rates and yields are still the dominant trends and there is no global forum to encourage an alternative route. Global policy harmonisation is dead in the water thanks to Donald Trump’s past actions.

We are slipping inexorably towards the next recession and that means trouble for markets and investors. The 2008 crash proved there are few places to run and hide when the chips are down. Equity and credit markets are set for troubled times and it is really down to how far they tumble before bargain seekers set a floor. Judging by current equity valuations, the descent could be painful next year. A steep correction looks increasingly likely. Investors may look to defensive stocks to help hedge their bets, but this is simply re-arranging deck chairs as the ship goes down. It is time to man the lifeboats.

So, what can investors hope to accomplish in 2019? The priorities are risk aversion, capital protection, flight to quality and the need to hunker down until the dust settles. It might be a long wait, as the years following the 2008 crash proved. Shifts into ultra-safe government bonds and buying safe-haven currencies like the Swiss franc, Japanese yen and US dollar should set the trend. Unfortunately, these trades are already looking crowded and causing headaches for policymakers.
It could be bad news for Beijing as a stronger US dollar could cut through the weak yuan like butter. A trade through Beijing’s implied 7 dollar-yuan exchange rate ceiling would be an early casualty, and no wonder the government favours a fiscal response to China’s slowdown over more monetary easing to tackle the coming chill. While lower interest rates are paramount to speed the economy’s recovery, it would be like waving a red flag at dollar/yuan bulls.
The best investors can expect in the circumstances is to scale back risk and liquidate – cash is king for those seeking damage limitation. In the worst-case scenario, don’t rule out lower interest rates ahead. There is a good chance that the US Federal Reserve will need to cut rates again in 2019 while the European Central Bank may have to put tightening plans back into deep freeze. China still retains the option to cut rates again to stop economic growth slipping below 5 per cent next year.

For sure, 2019 is squaring up to be the year of living dangerously, requiring extreme caution from investors.

David Brown is the chief executive of New View Economics

This article appeared in the South China Morning Post print edition as: 2019 will be a year of living dangerously amid the gloom
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