2019: an economic and market hangover from hell?

Sam Slator 14/11/18 in Strategy

As most of my friends and colleagues will attest, the older you get, the longer it takes you to recover from life’s excesses.

Whether it’s losing weight after indulging in too many desserts, or recovering from a night out consuming ‘one or two’ alcoholic beverages, age is simply not a friend.

But is this also true when it comes to economic cycles and bull markets that are arguable a bit long in the tooth too? Yes, according to one Elite Rated fund manager: “The global economy is set for a hangover in 2019”: the words of Ariel Bezalel, manager of Jupiter Strategic Bond fund.

Ariel had joined us, along with Fidelity Global Dividend manager Dan Roberts, to host a dinner for financial journalists, giving their outlook for 2019. They didn’t paint a rosy picture:

America first…

For the past decade, the US has led the rest of the world in terms of economic growth and stock market returns: the S&P 500 has returned almost 200%* more than the rest of the world in sterling terms.

“While the top contributors to the performance of the S&P 500 were reasonably well diversified in terms of sectors from 2010 to 2016, the past two years have been characterised by the rapid growth of US technology companies,” said Dan Roberts.

When Amazon’s market cap reached $1 trillion for the first time this summer, Amazon had just about doubled its size over 12 months: as Dan pointed out, this growth alone was larger than the GDP of Belgium!

However, Dan warned about the amount of debt held by US companies in particular: “They have taken on too much debt – mainly to finance mergers and acquisitions and share buybacks and they have not invested for the future,” he said. “The consensus is that we are late in the market and economic cycle… but not quite ready for a recession” he concluded.

Ariel was particularly negative on the outlook for the US. “US house builders and auto companies are already in a bear market,” he said. “The US housing market is starting to crack. The US consumer is up to their eyeballs in debt and has not seen much in the way of wage growth this cycle.”

Recession looming?

“I’m the most bearish I have been for a decade,” Ariel told us. “Structural problems in the world are worse today than they were in 2008, when we had the global financial crisis. Corporate debt and debt to GDP is at a higher level, and the demographic profile is unfavourable to economic activity (even in some emerging markets). And while there was a co-ordinated global effort to deal with the global financial crisis, we are now in a much more fractured world where it’s every man for himself.

“I think we are 12-18 months away from a global recession. There are a number of signals that prompt me to say this:

  1. Almost every recession in the post-war era has been brought about by the Fed raising interest rates until something breaks.
  2. We’ve seen two drops of 10%+ in stock markets this year. Each time this has happened in the post-war years it has also been a precursor of recession.
  3. Government bond yield curves are flattening.

What is a yield curve and why should you care? 

“These are all classic late cycle signals,” Ariel concluded. “Unconventional monetary policy will be with us for a long time to come. I think the US central bank will capitulate on its interest rate hiking cycle in the next few months and, by the end of 2019, other quantitative easing methods will have restarted. All this means is that the bond bull market still has a long way to go.”

Late cycle investing

While stock and bond markets are likely to be trickier to navigate in 2019, both managers agreed there are a number of tactics that can be used to make the most of the end of an economic and market cycle.

Keeping some money in cash so that you can invest on the dips is one way of making the most of volatility. Good gains can still be made in equities at the end of cycle, so you may still want to have an allocation to the asset class. By buying on the dips you can also buy shares in companies you like, but at cheaper prices.

Another option is buying ‘short duration’ bonds. These bonds are less sensitive to interest rate rises, as they are close to maturity (when the initial investment is returned to shareholders). Ariel has some exposure to short-dated emerging market bonds in the Jupiter Strategic Bond fund.

He gave the example of Sri Lanka, which has faced a number of issues in recent months, but where he feels default risk is low as the International Monetary Fund has recently ‘written the country a cheque’. He has invested in a bond that is due to mature as soon as January 2019, and which has a yield of 8%. He has also invested in an Argentinian bond that is due to mature before the election next year, also with a yield close to 10%.

Ariel also likes US and Australian government bonds. “I don’t think the yield on US treasuries can go much higher,” he said, “so I like them as an investment right now.

The final option the managers discussed was gold, which is often seen as an ‘insurance agains the end of the world’.. Ariel holds the bond of a South African mining company but investors can choose to add a gold fund to a portfolio.

*Source: FE Analytics, S&P 500 and MSCI ACWI Index over 10 years to 13 November 2018. total returns in sterling.

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