At the start of 2018, optimism reigned among policymakers and market participants, as it appeared that the synchronized global growth of 2017 marked the point at which the global economy had finally left behind the period of rolling crises that began with the global financial crisis back in 2007.
With the economic volatility of the post-crisis period behind us, a serene economic expansion was seen as likely to deliver healthy returns for risk assets. However, that optimism proved misplaced: the Crisis, Response, Improvement, Complacency (CRIC) framework we have found useful for navigating the ebb and flow of markets post-financial crisis remained relevant in 2018.
The synchronized global growth of 2017 led to ‘complacency’ among policymakers, which in turn led to policy tightening – both by central banks and by authorities in Beijing. Last year saw a sharp slowdown in credit creation from both central banks and the private sector and, as a result, 2018 was the year that global money growth stalled. The reversal of the 2016/17 credit surge has led to renewed asset-price declines and waning economic momentum.
Here We Go Again
So, with respect to the outlook for 2019, did 2018 constitute another crisis to which we will see a renewed response from policymakers? Over the course of 2018, in reaction to flagging economic momentum and ailing markets, a slew of measures were announced to stimulate the Chinese economy, particularly in the second half of the year. However, it appeared that policymakers were still prioritizing financial stability over economic stability; credit growth remained subdued by Chinese standards and the shadow-banking sector remained in shutdown mode. With China’s economy continuing to slow towards the end of the year, and with data suggesting its manufacturing sector had contracted for the first time since 2016, have policymakers begun once again to prioritize economic stability?
2019 has begun with a raft of further easing measures in China, and the modest return of optimism has been aided and abetted by a less hawkish tone from the US Federal Reserve (Fed). As recently as December’s meeting, the Fed’s Federal Open Market Committee (FOMC) appeared resolute in the face of US equity and credit-market declines: interest rates would move higher and quantitative tightening (QT) would remain on autopilot.
However, when joining a panel discussion at a meeting of the American Economic Association in Atlanta (on January 4, 2019), Fed Chairman Jerome Powell struck a decidedly more dovish tone, intimating a pause in further rate hikes and a new found flexibility with respect to QT.
Is It Enough?
Certainly, Powell displayed greater empathy to the plight of financial-market participants than he had been willing to show up until that point. At the same time, it seems likely that monetary and fiscal policy in China will provide more support in 2019 than it did through 2018. The burning question remains whether all this will be enough to turn market fortunes around, and whether we will see a repeat of the 2016/17 reflation story?
While markets and economies differ today from late 2015 (the point at which the last policy-driven reflation of the global economy and financial markets began), it is worth reminding ourselves what that collective effort looked like.
After increasing interest rates in December 2015, for the first time since the global financial crisis, the Fed paused in much the same way that Powell has suggested the Fed will do today. However, in stark contrast to today, the second half of 2015 saw global central banks begin the largest combined intervention effort in history, to the tune of over $5 trillion of asset purchases between 2016 and 2017, spearheaded by the European Central Bank and Bank of Japan. Meanwhile, in China, the largest bank bailout in history paved the way for the biggest debt-fueled stimulus program ever seen.
At the start of 2019, we are not faced with a repeat of the combined global stimulus that reflated the global economy and markets in 2016 and 2017. Perhaps the cavalry will come once again, but it now remains somewhere just over the horizon.
2019: a Year of Two Halves?
As we look to the year ahead, we think markets are likely to remain volatile, and, as we survey the landscape, it appears that 2019 could be a year of two distinct halves. Right now, market participants appear willing to back the idea that policy easing will ensure continued economic expansion and an extension of the bull market. Rallying risk assets engender optimism and, as always, upside volatility re-energizes bullish market sentiment.
However, we believe this optimism sits uncomfortably against a backdrop of forward-earnings downgrades and continued economic slowdown. To this end, recent developments in credit markets serve as a warning.
Last year saw a steady rise in credit spreads globally – arguably an ominous development for corporate financial health in 2019. While earnings growth is likely to remain positive over the course of the year, on balance we believe the easing measures announced thus far are unlikely to arrest the ongoing deterioration in corporate earnings. Moreover, while the bulk of equity-market weakness in 2018 was driven by declining valuations, in our view the biggest risk to fragile equity markets in 2019 remains the continued deterioration of corporate earnings. Markets, after all, have a habit of leading the economy.Over the course of the year, we see the market as likely to reward balance-sheet strength and stability of cash flows above other attributes, and, with a decade of financial excess now behind us, we believe the risks are skewed very much to the downside.
This is a section from our recent paper on the outlook for markets in 2019. You can read the full paper here.
This is a financial promotion. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only. Any reference to a specific security, country or sector should not be construed as a recommendation to buy or sell this security, country or sector. Please note that strategy holdings and positioning are subject to change without notice. Compared to more established economies, the value of investments in emerging markets may be subject to greater volatility, owing to differences in generally accepted accounting principles or from economic, political instability or less developed market practices.
This is a financial promotion. Issued by Newton Investment Management Limited, The Bank of New York Mellon Centre, 160 Queen Victoria Street, London, EC4V 4LA. Newton Investment Management Limited is authorized and regulated by the Financial Conduct Authority, 12 Endeavour Square, London, E20 1JN and is a subsidiary of The Bank of New York Mellon Corporation. 'Newton' and/or 'Newton Investment Management' brand refers to Newton Investment Management Limited. Newton is registered in England No. 01371973. VAT registration number GB: 577 7181 95. Newton is registered with the SEC as an investment adviser under the Investment Advisers Act of 1940. Newton's investment business is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Material in this publication is for general information only. The opinions expressed in this document are those of Newton and should not be construed as investment advice or recommendations for any purchase or sale of any specific security or commodity. Certain information contained herein is based on outside sources believed to be reliable, but its accuracy is not guaranteed. You should consult your advisor to determine whether any particular investment strategy is appropriate. This material is for institutional investors only.
Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities, (ii) officers of the Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms, including Newton and (iv) representatives of Newton Americas, a Division of BNY Mellon Securities Corporation, U.S. Distributor of Newton Investment Management Limited.
Unless you are notified to the contrary, the products and services mentioned are not insured by the FDIC (or by any governmental entity) and are not guaranteed by or obligations of The Bank of New York or any of its affiliates. The Bank of New York assumes no responsibility for the accuracy or completeness of the above data and disclaims all expressed or implied warranties in connection therewith. © 2020 The Bank of New York Company, Inc. All rights reserved.