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At last, some good news: 2018 is behind us...

17 January 2019

A disastrous December brought to an end a year to forget for the financial markets: the S&P500 was down 9.18%, its worst month since February 2009, oil lost 10%, the US 10-year bond yield narrowed by 30 basis points, and we could go on.

Last month, we said that the emerging markets could rally, and while they duly outperformed other regions (-2.9% for the MSCI EM, a positive performance for emerging bonds in strong currencies, a rise in EM currencies), they were nonetheless not immune.

The unpropitious climate prevailing over the previous few months is still in place, but have the underlying factors remained the same? We would say they have, for the most part, but whereas political tensions dominated a few weeks ago (US-China, Brexit, Italy, etc.), concerns have mainly shifted towards fundamentals.

The main question now seems to be: what will be the growth story in 2019? And in particular, how will US growth fare, after a record year in 2018?

Investors have three main concerns:

  • "The positive impact of President Trump's fiscal stimulus is coming to an end, and US growth is likely to stall without it". We only partially subscribe to this view, since by our estimates, the fiscal impact boosted growth by 0.7% in 2018 and should add 0.3% in 2019 (tax cuts until April 2019 and a $36 billion increase in federal spending over the year).
  • "The flattening of the US yield curve indicates a recession is on the way". We do not share the market’s fears on this, as the yield curve can remain flat for an extended period without causing any problems. In our view, the difference between the return on capital and the cost of capital is more relevant, and this indicator is not highlighting any shortterm risks.
  • "The Fed made a monetary policy misstep in raising interest rates when the financial conditions are tightening". Of course, the Fed could have paused its rate hike programme in light of the market correction, but it would have had to prepare the markets first. And it would have also needed Mr Trump to refrain from commenting on monetary policy. From our standpoint, the misstep came in Jerome Powell’s statement in October, when he said that the Fed may go further than getting rates to neutral.

Overall, we are not particularly worried about the global or US economy in 2019. A slowdown is highly likely, but not a collapse. The oil price slide over the last three months should have a positive impact on consumption figures by mid-2019.

A number of political risks are continuing to affect the markets: firstly, Brexit, with the House of Commons’ vote in the week beginning 14 January, and the US-China trade negotiations. However, we don’t expect a "hard Brexit”, and we note a more constructive tone in the USChina trade talks.

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