With doubts over the ability of the US economy to outperform again in 2019, a geographically-diversified portfolio might make more sense for investors, particularly given the potential for a change in the direction of the US dollar, according to JP Morgan Asset Management’s Karen Ward.
This year has been characterised by the stellar performance of the US economy, which – boosted by president Donald Trump’s tax cuts – saw both growth and corporate earnings surge during 2018.
The robust expansion also helped drive unemployment down to a 49-year low in the world largest economy.
But unlike in 2018, Ward, who is the chief market strategist for Europe, Middle East & Africa at JP Morgan Asset Management, said the team does not believe the US will experience a significant economic outperformance in 2019.
“The fiscal stimulus that provided an intense sugar rush in 2018 is expected to fade in the coming quarters, and overall US GDP growth is expected to moderate to less than 2 per cent by the end of 2019,” Ward said.
“Growth in the major developed economies looks set to reconverge over the course of 2019 to a more lacklustre pace by recent standards, thanks in large part to Washington’s more hostile approach to trade.”
US GDP growth (annual %)
Source: World Bank
Given that corporate earnings growth should also converge towards a slower – yet still positive – rate of growth, Ward noted equity investors may want to consider regionally diversified portfolios and to focus on quality large-cap stocks in historically defensive sectors to reduce risk.
While noting the risks to corporate earnings are building globally, Ward said the relative attractiveness of fixed income as an alternative to equities particularly for European investors continues to be limited.
As a result, Ward said investors should be more conservative about the near-term returns they can expect to achieve from a balanced portfolio in 2019.
According to Ward, going into 2019 it will be important for investors to be wary of becoming over-reactive to political noise and opting for the consequent dramatic shifts in allocation.
“For one, decisions and sentiment can change quickly,” she said. “The US and Chinese authorities could yet return to the negotiating table and stem trade tensions.
“Indeed, the more that bad news builds in the near term, from either the economy or the markets, the higher the incentive for politicians to consider a more amicable conversation.”
Thus, in order to improve the resilience of the portfolio, Ward noted relatively small changes could be a good option.
“Within equities, look for regional diversification and consider moving to larger cap stocks, with a bias towards quality and value styles over growth,” said the strategist. “Fixed income should play a greater role but be selective and consider alternatives such as macro funds to add ballast to a portfolio.”
When it comes to the outlook for monetary policy, Ward said that the US Federal Reserve may become more data dependant, which makes it unlikely for rates to be raised much beyond the middle of the year.
Elsewhere, in Europe, she noted more sluggish growth may hinder the European Central Bank’s (ECB) attempts to normalise policy.
“Global monetary conditions will remain relatively loose, providing some solace for investors who had been concerned about the Fed hitting the brake,” she added.
US interest rates over 10yrs
Source: St. Louis Fed
In Ward’s view, however, the greatest conundrum is faced by UK.
Although a resolution to the current Brexit standoff will be beneficial for the domestic economy, Ward believes it is likely to challenge gilts and internationally-focused stocks as markets move into 2019.
Given that 73 per cent of FTSE All Share earnings are made overseas, she pointed out that UK investors will need to bear in mind the potential implications of a positive Brexit outcome.
“A positive outcome would be likely to result in higher sterling, hitting repatriated earnings for large-cap UK companies, even if they look attractive from a dividend yield perspective,” she explained.
Beyond Brexit, Ward warned there remain challenges for the European authorities in 2019, including the rise of populism and the stand-off between the EU and Italian government.
“Centrist politicians are still struggling to head off populist parties,” she explained. “With critical European Parliament elections coming up in May, the risks are rising that eurosceptic alliances will take a greater share of the vote.
“In that case, investors may become sceptical about both the longer-term prospects for integration as well as the ability of Brussels to provide meaningful leadership in the next downturn.
“We don’t expect Italy to consider leaving the euro, but the eurozone’s third-largest economy is slowing sharply as credit conditions tighten.”
These political instabilities, together with a more lacklustre pace of growth, could limit the ECB’s ability to lift interest rates in the second half of the year, Ward said.
While fiscal stimulus as well as growth are slowing in both the US and Europe, she noted the picture is different in China, where policymakers have put their feet back on the accelerator to see off the impact of slowing exports.
“Local government bond issuance is now ramping up in a bid to fund domestic infrastructure projects,” said the strategist. “The Chinese authorities face a difficult balancing act of maintaining the ‘quality over quantity’ agenda and reducing excesses and leverage in pockets of the economy, but at the same time sustaining a sufficient level of growth to support employment.
Chinese local government bond issuance
Source: JP Morgan Asset Management
“Stable growth in China will likely support neighbouring Asian countries, but elsewhere in emerging markets, growth and earnings are likely to continue moderating in reaction to the tighter policies that were deployed in 2018 to defend currencies.”
As such, she noted the outlook for emerging economies remains highly divergent.
Ward concluded: “Navigating a market cycle is a bit like flying a plane. The dangerous bit – the part you really need to get right – is the take-off and landing.
“Investors need to have a closer eye on the controls and not be distracted by the usual turbulence as we pass down through the clouds.”