Market Outlook Q3 2019: Ride the growth wave
We believe that the third quarter for financial markets will be a positive one for investors, despite the daily headlines about trade jitters and political haggling. Composure and a steady hand are vital for investors in an environment of solid economic growth paired with increasingly unpredictable tail risks taking all the headlines.
From a macro point of view, the global economy is currently finding its way out of the soft patch that started in late 2018 and is set to gather some momentum in the second half of 2019, according to our baseline scenario. After a confluence of special factors weighed on growth at the end of 2018, we expect economic news flow to improve in the months ahead. Income growth should lift domestic demand and in addition, virtually all major central banks have indicated that they will do whatever it takes not to choke the still-fragile growth. We also believe that monetary and fiscal impulses from the Chinese government and the expected widening of the eurozone budget deficit will unlock further growth potential. To put it in numbers, we see annual growth rates increasing towards 2.6% in the US and 1.3% in the eurozone in the second half of 2019.
The bull market in risk assets continues but corrections are becoming more frequent
The current market environment is nerve-racking for investors, not least because of the political news flow, which is fuelling uncertainty on an almost daily basis. However, investors need to hold their breath and remain patient. Composure and a steady hand are vital, as staying invested in risk assets never feels comfortable during short-term corrections. Added to this, after three years of attempting to tighten monetary policy, the US Federal Reserve was forced in March to abandon projections for rate hikes this year and indeed, we are now witnessing a further shift as the market anticipates that the Fed might even need to cut rates this year. Although overall market volatility remains surprisingly low, changes in volatility have become more pronounced. This may sound confusing but all that it means is that the bull market in risk assets is continuing but that corrections are becoming more frequent than in the first half of the decade, and that each of these corrections may present a new opportunity to gain exposure.
Risk factors that bear watching
Whilst we expect the global economy to improve in the second half of 2019, we cannot ignore the flashing warning signs that it might not all be plain sailing in the months ahead. Factors currently of concern include the continuing trade quarrels between the US and some of its main trading partners; the Iran oil situation; the possibility of the US Federal Reserve moving earlier than expected on rates; the homemade problems of the German car industry; Brexit and finally, any possible shutdown of the government in the US because of debt ceiling issues in the autumn.
History shows, however, that it is not the number of risks that matter but rather their potential to combine and trigger a downward spiral. We do not detect such a development at this time.
We maintain our positive view on the markets but this is subject to material tail risks and we remain wary of the damage potential of a multi-factor downward spiral.
With growth expansion on track, investors keep riding the growth wave
In a world of moderate growth and low policy rates, we still believe that risky assets will rule the roost. On the fixed income side, our preference is for credit risk over duration risk. We favour euro-denominated low-investment-grade bonds, hard-currency emerging market corporate bonds and US high-yield & low-investment-grade bonds. We doubt that the bond market can cater for all the yield-hungry investors and see capital flowing back into equities being supportive for the asset class in the foreseeable future too. Given the state of the global economy right now, we tend to favour cyclical segments over defensive ones and despite the current political and fiscal unknowns, we regard the Chinese equity market as a strategic investment in our asset allocation and maintain a core holding.
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