In 2018, cash outperformed most other asset classes. Will 2019 be different?

  • Tai Hui says a survey of the regional outlooks shows economic fundamentals remain stable going into a new year, though risks will persist
  • As has been the case this year, the complex mix of geopolitical tension and economic challenges specific to the region will keep investors on their toes
PUBLISHED : Friday, 23 November, 2018, 10:30am
UPDATED : Friday, 23 November, 2018, 10:24pm

This year is turning out to be an unusual one for investment. Despite no major economic or financial stress in the advanced economies, cash outperformed most other asset classes. The valuation “de-rating” in global equities so far this year has been as severe as 2000 and 2008, the last two bear markets, even as corporate earnings continue to be solid.

Asia investors may feel defeated and deflated, begging the question of how economic fundamentals could turn out in 2019. Developed economies’ growth should peak in 2018, according to the International Monetary Fund. A global recession is not imminent, but some factors supportive of strong economic growth in 2018 are likely to fade.

The US fiscal stimulus that has helped push growth to around 3 per cent in 2018 should ebb to around 2 per cent in 2019. Meanwhile, rising interest rates in the US, which will probably continue in 2019, should also gradually lower corporate spending, given companies’ relatively high levels of leverage. As spare capacity to facilitate growth becomes scarce, US economic growth will rely on greater productivity, which is more difficult to achieve.

Consumers will remain a bright spot, supported by healthy household balance sheets and a strong job market.

Investors may expect the Fed to blink. It won’t

The euro zone has posted a steady recovery in recent years despite political volatility. However, past political uncertainty hasn’t involved economies of significant magnitude or material changes in policy. If the situation in Italy – which is currently in a stand-off with the EU over wanting to end fiscal austerity – were to worsen, that would be of concern, given that Italy is the third-largest economy in the euro zone, after Germany and France.

In China, the latest switch in policy priorities, from deleveraging to more easing, should lead to a rebound in fiscal spending on infrastructure. However, it is less clear whether corporate investment will accelerate as well. Bank lending remains cautious despite the authorities’ encouragement, and companies’ appetite for borrowing to invest is still soft. Additional pressure on the Chinese renminbi, from the narrowing interest rate differential between the US dollar and the yuan, could also limit the extent of monetary easing in China.

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Consumption in China should remain resilient. While demand for big-ticket items, such as cars, softened in 2018, Chinese consumers are still embracing a broad range of services such as education, health care, financial services and tourism. Growth in 2019 should not deviate significantly from 2018’s official target of 6.5 per cent. The Central Economic Work Conference, scheduled to take place in December, should set the tone for policy over the next 12 months.

If all that sounds respectable for 2019, then the important question is, what can go wrong? Geopolitics remains at the top of the list of concerns that could upset a benign path for the global economy in 2019.

Although the ongoing US-China trade war could well persist, instead of an unrelenting conflict, it is more likely that Beijing and Washington will go through intermittent rounds of threats over tariff and export restrictions. The potential for further damage to their economies should help deter them from taking their threats too far. But the uncertainty from trade tension may lead the global business community to consider restructuring global supply chains.

Why a US decoupling from China may backfire

Tensions in the Middle East could generate a spike in energy prices, at a time when the US shale oil industry is struggling to expand to relieve supply levels, constrained by infrastructure bottlenecks.

And political developments in Europe could continue to challenge that region’s unity. While no members of the euro zone are likely to leave the bloc, tensions could spark financial stress for countries on the periphery, such as Italy.

Investor sentiment could turn more skittish as market participants shift their focus to growth and inflation data. Attention may also turn to more technical factors such as market liquidity, as well as the potential impact of financial innovations and regulatory change on market volatility.

As economic moderation sets in and uncertainty percolates as we approach 2019, it will become increasingly clear that slower labour supply growth and constrained productivity will sap economic strength at a time when receding monetary support from developed markets adds complexity to the mix. Be ready for an unpredictable ride.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management