November 26, 2018

T. Rowe Price believes that global growth is moderating into 2019 as stimulus tailwinds abate and output gaps close. The picture will be mixed in emerging market and developing economies, with slowing in China offset by acceleration elsewhere.

“We expect global growth to slow a bit in 2019, but fiscal stimulus will still provide a tailwind. History suggests that we will see another 175 basis points of rate hikes, and Fed tightening cycles should lift the real Fed funds rate at least to potential real GDP growth. In terms of risk, we see that the yield curve is flattening, but this does not mean recession is imminent,” said Alan Levenson, chief U.S. economist.

2018 was a tough year for asset prices and the economic cycle appears to be moving toward late-cycle.

“Divergence increases across multiple countries and sectors are making the current market environment more fragile. 2019 will be a challenging year ahead, but tactical opportunities can still be identified in unfavored assets and emerging markets,” said Thomas Poullaouec, head of multi-asset solutions Asia- Pacific.

Global Equity: Cautiously Optimistic but Expecting Markets to Be Choppy and Headline Driven

Strong earnings growth and renewed confidence in the economy drove the market’s rise. The U.S. market ascended to all-time highs before the October correction, which was driven mostly by concerns around a China tariff war and Fed tightening. “We are cautiously optimistic for the year ahead. Economic acceleration, high consumer and business confidence, strong earnings growth, the electoral cycle, and widespread innovation all favor a bull market in the near term. However, we will likely see a market tug of war, which should favour investment strategies that are opportunistic and focused on stock selection,” said John Linehan, chief investment officer, Equity, and portfolio manager.

Compared to developed markets, emerging markets have underperformed by a wide margin this past year. “Several themes support the ‘Bear’ case for in emerging markets. The rising dollar and rising rates are headwinds for emerging markets, and country-specific risks could trigger broader contagion. Additionally, trade tensions have the potential to derail Chinese and global growth. But we are on the lookout for factors that could be upside surprises in 2019, including innovation in China, rising profitability in Japan, and a possible Brexit resolution,” said Justin Thomson, chief investment officer, Equity, and portfolio manager.

Asia Equity: Continued Positive Earnings Growth Expected in 2019

For Asia ex-Japan equities, positive earnings growth is expected to continue through 2018-2019, albeit at much slower rate versus 2017.

“We are cautiously optimistic about Asia ex-Japan equities for several reasons, said Anh Lu, portfolio manager for the Asia ex-Japan Equity Strategy. “Valuations are attractive again relative to long term history and relative to developed markets. The risk of demand slowdown due to deleveraging in China and trade war tensions has already significantly reflected in share prices. We expect some policy fine tuning in China to accommodate economic growth and private sector investments should trade war tensions continue to rise over the next 6-12 months. Elsewhere in Asia, currencies and local rates have made most of the necessary adjustments to reflect stronger US dollar and rising USD rates.”

In general, we tend to prefer companies that are successfully boosting their innovation capabilities in areas such as health care, automotive, home appliances, robotics, environment, and other consumer applications. “We continue favoring companies that are gaining more market share and those that will benefit from pricing power and industry consolidation. We see value in companies with improving fundamentals due to capital expenditure discipline,” Lu adds.

Global Fixed Income: Increased Volatility in Risk Assets Driven by Reduction in Central Bank Asset Purchase

“Current market conditions show that after a lengthy period of coordinated easy global monetary policy, global liquidity has peaked. And despite generally positive economic conditions, pockets of volatility have begun to emerge. Looking forward, the U.S. economy appears to be moving toward late-cycle as short rates continue to rise and global monetary policy is increasingly divergent,” said Andy McCormick, head of U.S. Taxable Bond and portfolio manager.

Emerging markets bonds and bank loans are expected to do well as the end of tightening cycle approaches. In Asia, credit markets head into 2019 in a defensive mode due to concerns over slowing growth in China that are amplified by US-China trade tensions.

“Looking ahead, we believe that Chinese policy stimulus and stabilising trends in US interest rates will provide support for valuations. Currently, we see greater dispersion in credit spreads, with Asia high-yield bonds underperforming the most and presenting attractive investment opportunities. We expect strategies that focus on credit fundamentals and security selection will benefit most in this environment,” said Sheldon Chan, associate portfolio manager of the Asia Credit Bond Strategy.

Secular Risk as Key Challenge and Opportunity in 2019

In light of a challenging investment environment ahead, T. Rowe Price highlights the need for investors to identify the next round of secular risk, or the emergence of new disruptive forces in the economy, before the market does.

“Secular risk impacts roughly 30 percent of companies in the S&P 500, up from 20 percent just two years ago. Another 13 percent could be impacted in the next three years. The implications of secular risk for markets and investors are significant. Traditional mean-reversion investing will likely be less successful than in the past, and value investors will face a difficult challenge as the universe becomes predominantly economically cyclical stocks and secularly challenged stocks,” said David Giroux, chief investment officer, Equity and Multi-Asset, head of Investment Strategy, and portfolio manager.

Companies free of secular risk are likely to trade at higher valuations than they have in the past. Active managers who can identify these opportunities and underweight secularly challenged companies are therefore more likely to achieve investing success than index investors. “The emergence of secular risk will be a challenge to passive investing over the next five to 10 years,” Giroux adds.

Multi-Asset: Focusing on The Unfavored Assets

T. Rowe Price’s multi-asset division moved to an overweight position in emerging markets equities, as valuations have become very attractive on the back of recent underperformance. “While idiosyncratic and political risks remain elevated in several key countries, we do not believe these concerns pose a systemic risk. Despite trade tensions, emerging markets are likely to benefit from stable commodity prices, ongoing stimulus measures in China, and a more stable U.S. dollar,” said Poullaouec.