At the halfway mark, volatility persists amid fragile global growth

Investors began 2019 cheering the global rally in risk assets that followed a dramatic late-2018 market plunge. The tough fourth quarter caused the US Federal Reserve (Fed) to stop raising interest rates despite a relatively strong US economy, aligning the Fed more closely with other major central banks that are still keeping rates low.

However, as 2019 progressed, the markets turned volatile in the face of a fragmented economic environment with multiple pain points:

• Investors are caught in the disruptive fire of the US-China trade war, which is turning into a "tech cold war" that threatens to disrupt global supply chains.
• Europe is still vulnerable to Brexit uncertainty, and recent parliamentary election results may slow the European Union’s ability to make critical decisions.
• The US is continuing along its late-cycle path with growth stuck at less than 2% and rising expectations of a recession in 2020. Moreover, policy uncertainty related to the upcoming presidential election could create market headwinds.

Against this backdrop, we are closely watching the themes that will likely drive markets, regions and investors’ decisions throughout the remainder of 2019.

Key investment themes at the halfway point of 2019

With the Fed on hold, will the dollar slide if the debt ceiling lifts?
The Fed made a surprise U-turn to its monetary policy at the end of January. Instead of hiking rates further, as expected, the central bank put future rate hikes on hold. The market is even pricing in two rate cuts by the end of 2019 and four by the end of 2020. This shift in US monetary policy may ultimately weigh on the US dollar, especially if the US debt ceiling is increased this autumn against a backdrop of looser monetary policy. But general political uncertainty and ongoing easing by non-US central banks will likely prevent the dollar from falling further.

Takeaways for investors

• Interest rates now seem likely to remain lower for longer. With the market already pricing in several rate cuts, investors should expect continued low returns for traditional bonds – though they may be an attractive defensive option if recession risks rise.
• We believe the US dollar is likely to peak in value sometime during the second half of 2019; this may offer some relief to emerging-market assets in particular.

Polarised politics could mean higher volatility
Political incumbents around the world are feeling pressure to move away from the political centre on issues such as economic inequality and immigration. Yet markets have largely stayed calmer than expected about politics because of the difficulty of anticipating policy changes. That said, some geopolitical shifts are having direct effects on markets – for example, US pressure on Iran is raising oil prices, which is hurting consumer spending. This supports our view that all investors, particularly those focused on emerging markets, can benefit from an active asset-management approach and considered analysis of political risks.

Takeaways for investors

• With political uncertainty high, investors might consider pivoting towards income-generating investments and away from “riskier”, more volatile asset classes.
• Political events are hard to anticipate, but populism has been rising and politics are getting more polarised; an active approach may help make investment risks more clear.

A “tech cold war” could rage for years
Amid heightened trade tensions between the US and China, President Donald Trump has fired the first volleys in a tech cold war by targeting Chinese corporations for trade practices that many describe as unfair. Supply chains could be disrupted if countries are forced to choose between Chinese and American tech ecosystems while the two superpowers vie for leadership in big data and artificial intelligence.

Takeaways for investors

• The tech cold war could undo the globalised low-cost, high-margin supply chains of many US and Asian tech companies.
• With large American tech firms already under fire for privacy issues, new US-China tensions could cause their valuations and expected returns to decline.
• Cyber-security and defence stocks may benefit from rising geopolitical hostilities.
• With nearly every industry attempting to use technology to its advantage, investors will need to employ active, rigorous research as they aim to separate winners from losers.

Sustainability is a driver of long-term returns
Sustainability has quickly become a key area of focus for investors – and for good reason. In the light of increasing pressure from activists and investors, boardroom agendas are increasingly reflecting topics such as climate change, higher governance standards and board diversity. Companies that manage these environmental, social and governance (ESG) factors well are better able to strengthen their competitive positions. We believe investors should examine ESG factors for a critical layer of insight, aiming to identify key risks and opportunities that are not yet fully reflected in prices. This can have a direct effect on risk-adjusted returns.

Takeaways for investors

• Done well, sustainable investing is about managing risks and improving performance. This is what drives our “integrated ESG” approach. In a systematic and disciplined way, we incorporate ESG factors into our existing investment processes, using our proprietary ESG research and the deep knowledge of our portfolio managers and analysts.
• We are also active stewards of the companies we own. We engage with companies with low ratings to help improve performance rather than exclude them outright.

Sustainability can mean many things – clarity is key
Investors can pursue sustainable investments in multiple ways, from integrating ESG factors into all investment decisions to investing with a specific societal impact in mind. This graphic shows how our offerings sit across the spectrum of sustainable investing capabilities.

Source: Allianz Global Investors.

Mid-year 2019 regional outlooks

US

The outcome of US-China trade negotiations seems uncertain: we see only slightly better-than-even odds of the two countries signing a much-needed agreement. Without a deal, US tariffs could expand into consumer-oriented areas, increasing the prices of imported goods. The Fed will watch inflation closely, especially if more trade tariffs are implemented. The US central bank may be less inclined to keep rates low if inflation moves higher, which could undermine support for high stock prices. Still, while the US economy remains late-cycle, it isn’t yet facing a recession, and President Trump will be eager to campaign on the economy’s strength in the upcoming presidential election.

EU

The second half of 2019 will be important for the European Union: the EU will appoint new members to its leadership team, including a new chair of the European Central Bank (ECB). Support for mainstream pro-European parties held up in recent Parliamentary elections, but the legislative body will likely end up more fragmented and decision-making could slow. The banking sector is still wobbly, and we expect the ECB to be ready to add further liquidity support – which may keep the euro weak. Worries over global trade could suppress Europe’s economic growth, as could EU-US tensions over NATO, Russia and Iran.

UK

Economic and corporate uncertainty is being prolonged by the extension of the Brexit decision until 31 October. Additional questions are being raised by the contest to succeed Prime Minister Theresa May, and how the new Prime Minister will influence the future path of Brexit and policy-making overall. Low investment and dull consumer confidence are also adding to the UK’s economic limbo. With little consensus on the way forward, a “hard Brexit” – one without an agreement with the EU – remains a credible outcome. The result could be notable economic pain, though hopefully only in the short term. Yet with many investors already reducing their UK positions, the country and its currency may be unloved, under-owned and undervalued.

China

China is focused on playing the long game – rebalancing its economy towards one focused on consumption; reducing corporate and government debt; and forging strategic alliances throughout Asia. But now, China is in a blow-for-blow trade and tech battle with the US. China’s future actions could be severely disruptive, but the country ultimately wants to attract foreign capital by diversifying and deepening its financial markets. Over the rest of 2019 and into 2020, President Xi Jinping may be inclined to push key decisions down the road, hoping a new US president will take office.

Asia

Looking at Asia more broadly, spending by Asia’s consumers could slow if the price of oil spikes due to geopolitical tensions in the Middle East. Even so, Asian equities still appear attractively valued, and Asian bonds – particularly USD-denominated ones – offer attractive yields for long-term investors. And we continue to believe that over the long term, Asia will be the engine powering global growth. Developed economies are ageing, grappling with high debt levels and addicted to easy money from central banks. Meanwhile, emerging Asia has a youthful population of nearly 4.5 billion, and its reform-minded governments want to reduce their dependence on the West.

Growth is slowing across much of the world – but it’s higher in Asia
GDP forecasts (year-on-year; in %)

 

Source: Bloomberg. Data as at 7 January 2019. *GDP figure for India for 2018 is actual, not forecast. The above is for illustrative purposes only and is not a recommendation or advice to buy or sell. Past performance, or any prediction, projection or forecast, is not indicative of future performance.

Investment implications

1. “Riskier” assets may hold up as long as recession risks – or trade threats and retaliation – are contained. But if economic data start to deteriorate, government bonds may be an attractive option, despite low yields.
2. Take an active approach to investing: watch out for high-priced assets and take contrarian positions when attractive valuations can be found.
3. “Use ESG factors to help manage risk and drive performance; sustainability is becoming increasingly mainstream for a reason.
4. With returns on “safe” cash assets stuck at low or even negative levels, the biggest risk is still to take no risk.

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