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Our 2019 Outlook

Written and accurate as at: Dec 20, 2018 Current Stats & Facts

Sharemarkets across the globe have continued to be battered by two big fears for 2019: the potential damage from a U.S.-China trade war and the prospect of a U.S. economic slowdown. There has also been a slew of other worries, including slower eurozone growth and Brexit.  Looking ahead, while all the recent focus has been on downside risks, the long post-GFC economic recovery is still intact, although there is the potential for ill-advised political brinkmanship to derail the cycle.

Locally, there’s a wait-and-see sentiment pervading business and investment. The federal election, likely to occur in May, should see huge surplus-busting spending promises from both sides of politics. Labor is sticking with its proposed negative gearing and CGT changes despite the housing market downturn in Sydney and Melbourne generating fears of a recession. The banking Royal Commission hands down its findings in February, but lenders have already acted, with credit growth at record-low levels. So much so, APRA will limit the banks to having no more than 30% of their loans as interest-only being effective from the first day of the new year.

The official data for GDP growth in September sprang a somewhat unpleasant surprise with growth coming in at half of what was expected. This was largely due to cautious behaviour by households, who increased their spending by only 0.2%. The numbers were hardly a disaster—year-on-year GDP growth was still an internationally respectable 2.8% and continued a 28-year uninterrupted run of expansion.

Perhaps the most authoritative take came in the government's Mid-Year Economic and Fiscal Outlook where the immediate outlook isn't as strong as the government had expected back on Budget day in May, with GDP growth for the year to June 2019 likely to be 2.75% rather than 3.0%.  Whether it is enough of an acceleration to generate a gush of corporate profits and a boost to share prices remains questionable, however. Even on the government's projections, corporate profits are facing headwinds. 

The Australian sharemarket has been an underperformer for some time: capital gains in particular have been hard to come by, with the S&P/ASX 200 index recording only a 1.3% a year gain over the past five years. While reasonable though not robust economic growth will provide some support, the headwinds from a cautious consumer, weakening commodity prices, falling house prices, and the still under-pressure financial sector look likely to lead to another period of subdued performance.

The recent weakness of global equities reflects two large concerns that have come to the forefront of investors' attention: the prospect of economic disruption from an intensified tariff war between the U.S. and China, and the potential for the U.S. economy to slow down in 2019 as the fiscal boost from the Trump tax cuts drops away. There has even been speculation that an outright recession in the U.S. is not far away.  It has not helped that the latest worries came against a background where investors had already been fretting about the potential for the Fed to make a too-tight monetary policy mistake, and when U.S. share valuations were quite expensive by historical standards, leaving little room to withstand disappointed expectations. 

Even though this weakness is understandable, the case for equities is not as uniformly pessimistic as the headline alarm might suggest.  While the outcome of the U.S.-China trade frictions is hard to predict, it may turn out better than investors currently anticipate. Previous investor alarm over unexpectedly confrontational U.S. policies—notably against North Korea and the NAFTA free trade agreement—ended up less bad than feared.  The U.S. slowdown also needs to be viewed in perspective. Currently, the consensus forecast for the U.S. economy, from the WSJ forecasting panel, is that it will still grow by 2.3% in 2019, and as noted earlier fears that the Fed would precipitate something worse are being revised. After yesterdays move the Fed is now expected to be more cautious about interest rate hikes. The U.S. profit machine has not yet stalled: the latest consensus forecast from sharemarket analysts, as collated by data company FactSet, is that profits for the S&P500 companies will grow by 8.3% in 2019.

There are, it is true, good reasons to expect that both the U.S. and the global economies will grow more slowly in 2019. The latest (November) J.P. Morgan IHS Markit global composite indicator found that "Forward-looking indicators for the survey raised some potential headwinds regarding the outlook for output growth ... Business expectations regarding the outlook for economic activity during the year ahead dropped to the lowest level since September 2016."  But in the current climate, worried investors are finding it hard to distinguish between a slowdown and a collapse.

The outlook for the global economy may not be as strong as previously, but is not outright poor. The Market Outlook 2019 forecast from Bank of America Merrill Lynch, or BAML, for example, expects the world economy will grow by 3.6% next year, which would be only slightly slower than this year's 3.8%.  Some of the other concerns also look overwrought. London's Financial Times, for example, reported that "[November] Retail sales grew at the slowest pace in 15 years in November in China, while factory output was the weakest in nearly three years." While correct, the actual numbers remained remarkably strong—retail sales were up 8.1% on a year earlier, and industrial production was up 5.9%.

There’s a lot going on. It’s easy to get caught up. Hindsight has taught us much.  Past political and market crises which seemed disastrous as they occurred, are little more than blips on the market radar, which over time, continued its upwards trajectory. Importantly, those periods of enhanced volatility created buying opportunities, and savvy investors that had the confidence to buy stocks in good companies whilst the majority were selling were rewarded over the long run.

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