The year 2018 was the worst since 1901 in terms of declines across a broad base of assets.
Research by Deutsche Bank across a sample of 70 global asset classes found that 90% produced a negative return in 2018 (in US dollars), surpassing the previous worst-ever year, 1920, where 84% lost value.
The regime change from quantitative easing (QE) to liquidity withdrawal is a key factor behind this striking pattern of declines. It is exacerbated by concerns about trade disputes and a weakening global economy.
As the chart below suggests, equity markets are pricing in a deep contraction in US activity. The year-on-year changes in the S&P 500 Index, which have occupied positive territory for most of the past decade, have turned sharply negative (blue line).
The S&P 500 Composite forward price-to-earnings ratio tells a similar story: it fell from 18.5 at the start of 2018 to 14.3 by the end of 2018, below its long-term median of 15.6.
As markets fear for the worst, what may go right in 2019?
Progress on US-China trade talks
December’s “truce” between the two superpowers stipulated a 90-day timeframe, but it is yet unclear whether progress will be made within that window.
Ultimately the hurdles to be overcome are complex and there remains a lot of uncertainty. Stumbling equity markets and slower growth in both China and the US may exert pressure on both sides to deliver progress.
A pause in interest rates and a weaker dollar helps emerging markets
Recent comments from Federal Reserve Chair Jerome Powell suggests the Fed may adopt a more data-dependent approach to future rate increases.
The Fed now expects two rate increases in 2019 instead of three previously, while markets are pricing in none. If this less aggressive attitude toward rate rises unfolds, the dollar is likely to weaken in 2019 which would be helpful to developing market assets.
Lower oil prices boosts real income
As the boost from President Trump’s tax cuts starts to wane in 2019, the slump in oil prices will provide another form of windfall for US consumers. The latest US labour market report points to robust hiring and nominal wage growth. Persistently low oil prices during 2019 will boost real income growth and support consumer spending.
Governments turn to fiscal easing
The deterioration in Chinese growth, due largely to trade tensions, has prompted range of stimuli, most recently the 100 basis points cut in the reserve requirement ratio for large and small banks. We expect further easing measures if tensions persist.
Globally, rising populist influence may pressure governments to increase public spending or enact legislation increasing benefits or minimum wages, along the lines of President Macron’s reaction to “yellow vest” protests in France.
Political uncertainties resolve
Political developments will continue to loom over markets and economic prospects in 2019. But recent newsflow in relation to European politics has improved, most notably in the form of an agreement between Italy and the European Commission on the Italian budget. This appears to have removed one major risk event.
In the UK, Brexit is the biggest uncertainty holding back investment decisions. We will get more clarity following the Brexit vote next week.