Catella : Market View 2019

One requirement for a prosperous global economy is strong growth in China, the United States and India. A rough estimate shows that China accounts for 25 percent of world growth, India 12.5 percent and the US 12.5 percent, and the result is that three countries account for half of global growth. On top of this, Europe and Japan are large and mature economies with lower growth rates, but a change in their pace has a major impact on the world economy.

Global growth prospects were revised downwards in 2018 and will be adjusted down in 2019, mainly because of a number of uncertainties. Last year, the US Federal Reserve raised key interest rates and began reducing its balance sheet. There is great uncertainty surrounding this balance sheet reduction since there are no historical references. Furthermore, there were additional sources of concern during the year in the form of a trade war and uncertainty about the UK's exit from the EU. Anxiety has an adverse influence on financial markets, and can also cause companies and consumers to postpone decisions on investment and consumption. Weaker growth prospects may seem somewhat surprising since both fiscal policy (1) and monetary policy (2) are expansionary in the most significant economies. Although one parameter affecting growth prospects in the shorter term is the uncertainty mentioned above, a second is the historically high indebtedness in the economy. And a third parameter is that the global economy has become increasingly dependent on how the asset markets perform. This phenomenon is self-reinforcing, which means that a strong stock market leads to more vigorous economic growth, which in turn gives rising share prices in the markets. Of course, it works the opposite way when stock prices fall.

Our view for equities in 2019 is that the financial markets have priced in weaker earnings performance than analysts are projecting. One consequence of the share price declines is that the valuations now look more attractive than they have for a long time. For example, every krona of sales on the Swedish stock exchange is being priced at the same levels that prevailed after the 2015/2016 downturn. We anticipate downward adjustments to companies' expected profits in the first half of 2019. Historically, this sequence of events has meant that the market is nervous and is torn between hope and despair, and reversing the trend normally requires stimulus in the form of fiscal or monetary policy.

If we draw historical parallels with the situation today, it is similar to the course of events in 2015/2016. What caused the mood to swing that time was intense stimulus in China and later fiscal stimulus in the US, launched by President Trump. How likely is something similar in 2019? Unfortunately, significantly less likely than in 2015/2016. Above all, fiscal policy is already expansionary and the scope for fiscal stimulus is limited. The threshold for more expansionary monetary policy is also higher than in 2015/2016 since unemployment is lower and inflation is higher today than at that time.

Is the conclusion of this reasoning that we are facing a really tough winter, both economically and fiscally? Not necessarily. In terms of valuation, the stock market looks better than it has done for many years. The expected returns on secure bonds are far too low to be a long-term investment alternative. Even though fiscal policy is already strained, central banks in China, the US and India have room for stimulus. Last but not least, expectations changed in the latter part of 2018. Investor mentality has shifted from worrying about missing out on share price gains to worrying about losing money. Going against the flow is often a good idea when investing.

In conclusion, we believe that the performance of the financial markets in 2019 will be weaker than in a typical year, and the first half will be challenging. In the second half, it is possible that stimulus will provide support for the stock market. This could mean that, by December, the stock markets will be at about the same level as on the first day of January. Fixed income rates, which are already low, also have the potential to trade on par with, or slightly above, the levels at the start of the year. The range of outcomes is greater than it has been for a long time, so remember the words of Karl Kristian Steincke, 'It is difficult to make predictions, especially about the future.'

However, the over-indebted world economy is like an addict who needs a fix. And the fix is fiscal and monetary stimulus, without which there would be a global recession. The first step to becoming drug-free is reduction, and this is now being postponed which pushes a non-dependent world even further into the future.

1. The budget deficit in the most significant economies amounts to just over 3%.
2. A simple rule of thumb for monetary policy is that it is expansionary if policy interest rates are lower than nominal growth (real GDP + inflation).