OUTLOOK

2019 Global Market Outlook – Q3 update:
China syndrome

China stimulus, global central bank easing and a U.S.-China trade-war ceasefire could set the scene for a rebound in the global economy later in the year. However, the inversion of the U.S. yield curve and the downtrend in business confidence indicators keep us cautious at mid-year.

Introduction
China syndrome
  • Re-escalation of U.S.-China trade war adds to uncertainty.
  • High yield credit is expensive and losing cycle support.
  • Emerging markets will benefit from China stimulus.

INVESTMENT STRATEGY
Fork in the road
  • Fading fiscal stimulus is likely to slow the economy.
  • Momentum indicators have turned higher with the strong year-to-date equity market rally.
  • Positive central scenario with asymmetric risks to the downside.

U.S. OUTLOOK
Failure to launch
  • Growth indicators are lackluster.
  • Eurozone equities are close to fair value.
  • Optimism on Europe requires an easing in global trade tensions.

EUROZONE OUTLOOK
Expecting China stimulus to ease trade pain
  • Chinese policy stimulus should benefit the region.
  • Equity valuations look attractive in Japan and emerging Asia.
  • Bond valuations in the developed economies look expensive.

ASIA-PACIFIC OUTLOOK
EM currencies to benefit from USD peak
  • We believe the U.S. dollar is near its peak for 2019.
  • Among developed markets, the Japanese yen looks best.
  • Emerging markets currencies are attractively valued.

CURRENCIES OUTLOOK
Countdown begins
  • Model indicates 32% chance of U.S. recession in 12 months.
  • Short-term recession risk remains low.
  • We’ve staged some initial cyclical downgrades on equities.

QUANTITATIVE MODELING

Introduction

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The inverted yield curve, trade-war uncertainty and global data weakness argue for caution. On the other hand, U.S. Federal Reserve (Fed) easing, China stimulus and a U.S.-China trade deal could trigger another bull run. But it’s late cycle, the downside equity market risks outweigh the upside and betting on a market friendly outcome at mid-year 2019 is risky.

Inversion aversion

Bond and equity markets are arguing with each other. Bond markets see trade-war escalation, weak global data and declining inflation expectations. Equity markets see Fed easing, China stimulus and a trade deal with China ahead of U.S. President Donald Trump’s 2020 re-election campaign.

The bond market isn’t always right, and the equity market story has some appeal, but there is one heavyweight indicator on the side of the bond market – the inverted yield curve. This has predicted every U.S. recession over the past 50 years. The inversion needs to be sustained for a couple of months to provide a strong signal, but it makes a persuasive case for caution.

Paul Eitelman thinks that the Fed is now on track for one or two precautionary rate cuts. U.S. inflation is below 2% and market inflation expectations are low, which biases the Fed towards taking out some insurance against a downturn. The U.S. equity market is expensive and there is pressure on the cycle, which adds to Paul’s caution.

Europe is struggling to rebound from last year’s growth setbacks, although Andrew Pease expects there will be some improvement. The trade-war dominates, however, and optimism on Europe requires an easing in global trade tensions.

Not surprisingly, the trade-war also dominates the Asia-Pacific outlook. Alex Cousley sees China stimulus and central bank easing across the region. Exports, however, are under pressure. Adding to concerns are that Japan seems likely to proceed with the October hike in the consumption tax rate. On the positive side, equity valuations in Japan and Emerging Asia are slightly cheap, but a positive view on the cycle requires confidence in a trade-war resolution.

Van Luu and Max Stainton think the shift in Fed action towards easing will signal the peak in the U.S. dollar. Emerging market currencies at near-decade lows are likely to be the main beneficiaries of the softer greenback. The Japanese yen stands out as the preferred currency on valuation grounds and because of its safe-haven properties during risk-off episodes.

The recession probabilities from Kara Ng’s U.S. business cycle index model have moved into the warning zone following the yield curve inversion. The model’s recession probabilities have not yet reached pre-2008 levels, but the readings are high enough to reinforce the note of caution that our qualitative assessment is providing at mid-year.

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