We’re used to the ups and downs of different business cycles, and we’ve come to expect and prepare for them. But with unusual circumstances such as a trade war and the reversal of quantitative easing, the outlook becomes harder to predict. As risks build across the global economy, here are the key things we’ll be looking out for in 2019:
1. Slowdown in the US economy
Although the US economy continues to outpace the rest of the world, there are early signs of weakness.
Unemployment is still low, but there have been some meaningful lay-offs, namely Ford and General Motors. It’s not clear if these lay-offs are down to a generally slowing economy, or just challenging conditions within specific industries, but we’ll be watching closely to see if other sectors follow suit.
We’re also seeing US home sales declining with properties proving harder to shift. Indeed, the housing inventory available to buy shot up from 4.9 month’s supply at the end of May 2018, to 7.4 month’s at the end of October 2018 – a clear sign of a slowing property market.
At the same time, we’re seeing banks extending less commercial credit. That means fewer businesses are borrowing money, which in turn could lead to slower growth and lower company earnings.
These could all be signs that US growth is slowing down to a more sustainable level, where continued productivity gains and modest population growth are the structural drivers. We’ll be monitoring how growth responds to more restrictive monetary policy, and provided the slowdown is modest, equity returns should be acceptable.
2. A resolution to trade uncertainty
The outlook for the US economy is further obscured by its ongoing trade war with China. In late 2018, the International Monetary Fund (IMF) reduced its growth expectations for the US from 2.9% to 2.5%, citing the trade war as its key concern.
So far, China seems to be bearing the brunt of the stand-off. By the end of last year, exports went from 12.6% in October to 5.4% in November, while imports went from 20.3% in October to 3% in November. The ripple effect of this political posturing has been felt across the world. Big trading partners with China, such as Germany and Japan recently reported a single quarter of economic contraction towards the end of 2018.
As we start a new year, there’s seems to be little hope of resolving the crisis between the two super powers. Perhaps a weakening in US economic growth could prove to be the catalyst to making this happen?
3. Will banks continue to extend credit?
One of the big questions this year is whether companies will be able to grow their earnings. There are two ways of doing this – improving productivity by reducing costs, or achieving growth through sales, which is usually driven by product development and investment. The latter is inextricably linked to the ability of banks to extend credit to businesses, and the willingness of those companies to take on the debt.
As you can see from the chart below, the banking system has been extending less credit in recent months, which gives us cause for concern. We’ll be keeping a close eye on this as the year progresses, as it will surely impact on earnings growth in the months and years ahead.
4. Normalisation of monetary policy
The continued normalisation of monetary policy is now being questioned as several members of the Federal Open Market Committee are concerned about ‘inverting the yield curve’. If that happens, long-term interest rates fall below the level of short-term ones, and a downturn (perhaps even a recession) becomes probable. In this scenario, a pause to rising interest rates is possible, as central banks appraise whether economies can handle higher interest rates.
“As a result of increased uncertainty around the direction of economic growth, we’ve further reduced our equity holding to manage developing risks.” - Philip Smeaton, Chief Investment Officer