How will equities perform in a challenging environment marked by political tensions and rising interest rates? Here are our forecasts for the next 12 months.
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Equities across the world delivered a mixed performance in 2018. The beginning of the year saw the bull market in US stocks gathering pace, but wobbles in the tech sector brought a swift halt to the rally in October.
The trade dispute between the US and China – and fears of a knock-on impact on growth in trade-dependent economies – has also contributed to underperformance, with emerging markets particularly badly hit. In the UK and Europe, uncertainties surrounding Brexit and the Italian budget created further headwinds.
So will 2019 bring further bad news, or could global markets bounce back? In this article Aviva Investors’ fund managers set out their predictions for the coming months.
1. Outcome of trade dispute will influence performance
The ongoing trade dispute between the US and China is likely to weigh on performance in 2019, especially if no deal is reached to prevent further tariff increases. Levies on Chinese imports are already affecting business sentiment and could result in lower consumer spending in the US if companies pass on higher costs to customers. China’s retaliatory tariffs on US exports of commodities such as soya beans and crude oil are also starting to have an impact in those sectors.
The trade tensions have hit other regions, such as emerging economies, especially hard. In markets like the UK, much of the negative news flow has already been priced into valuations of the companies perceived as being most at risk. A de-escalation of the tariff dispute could therefore lead to a significant rally among UK-based international firms, particularly in the mining and industrial sectors.
2. Rate hikes threaten indebted US companies
Tighter monetary policy is likely to have a big influence on equity performance in 2019. In the record low interest rate environment, companies took advantage of relatively cheap access to finance to boost their growth with debt. A further consequence of low interest rates was an abundance of liquidity, which acted as ‘a rising tide for all boats’ for companies that geared up their balance sheets. Now, with financial conditions tightening and interest rates rising, companies with excess leverage could be particularly vulnerable – especially in the US, which is more advanced in the tightening cycle.
We expect moderate inflation will prompt the European Central Bank (ECB) to implement a rise in interest rates in 2019. The wider European financial sector would likely perform well in this scenario, potentially creating an opportunity for equity investors, as bank stocks currently look cheap on a price-to-book basis. Conversely, European consumer staples companies have grown expensive as investors prize their defensive qualities, so we are currently avoiding the sector.
3. Resolution to Italian stand-off would boost sentiment in Europe
The outcome of the stand-off between Italy and the European Commission is likely to have a major influence on European equities in 2019. Italy’s coalition government has ripped up an earlier commitment to cut borrowing and wants to implement a budget that would breach the commission’s fiscal rules. The confrontation has stoked Euroscepticism in Italy and weighted on markets, but the worst-case scenario troubling investors – an Italian exit from the European Union – is unlikely.
In the near term we are optimistic there will be a resolution to the budget stand-off, which would benefit Italian financial stocks in 2019, although smaller Italian banks remain vulnerable due to funding concerns. Some commentators have expressed worries over how the cessation of the ECB’s quantitative easing programme will affect Italy, but we believe the economy should be able to weather the withdrawal of central bank support.
4. Emerging markets offer stock-picking opportunities
Following a prolonged period in which macroeconomic drivers dominated asset pricing in emerging markets, company fundamentals are likely to reassert themselves in 2019. Many emerging economies are still growing at a faster pace than their developed market counterparts. With shares having been repriced, valuations now look more attractive.
Select emerging market technology stocks may offer bargains. In 2018, technology companies in developing economies were hit by a one-two punch; first by the emerging markets rout and then by the selloff in US technology companies. Not all EM tech companies are dependent on US tech giants for growth, however. Nor are they as exposed to US-China trade tensions as their share prices might suggest. With US tech stocks under increasing pressure, the discount offered by certain EM tech companies may prompt some investors to refresh their portfolios in 2019.