In this month's edition:
Can global equities regain their poise?
Global equities are on track for their first calendar year loss since 2011. Although we will continue to monitor potential threats – including rising yields and trade tensions – we recommend an overweight to global stocks, which are bolstered by strong fundamentals and appealing valuations.
Did you know?
Our base case is for US-China trade tensions to worsen before they get better. However, tariffs on US-China trade are unlikely to be significant enough to cause a global market shock, in our view.
History shows that Chinese authorities counteract slowing economic growth effectively. The People’s Bank of China (PBoC) has already cut the reserve requirement ratio for banks by 250bps this year, and the government has authorized local bond issuance to fund infrastructure projects.
Staying invested is important. In the postwar era, the S&P 500 has delivered positive returns 2.3x more often than negative returns over six-month periods, and 5.8x more often over five-year periods.
Should an inverted yield curve worry investors?
The first inversion of part of the US yield curve in more than a decade has unsettled equity markets, as it is often seen as a precursor to a recession. But the parts of the curve with the best track record of preceding recessions remain positive. Even if the 2s/10s spread does invert, a recession starts, on average, only 21 months later, and US equities gain, on average, 29% from the inversion to the market's peak.
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Economic cycles are often ended by central banks over-tightening. But this risk appears to have receded recently. In late November Federal Reserve Chairman Jay Powell said that rates are “just below” neutral and that further rate hikes will be data-dependent.
The Fed funds rate and 10y US yield have gone above the level of US nominal GDP growth near the end of each business cycle and bull market. We forecast nominal growth of 5% in 2018 and 2019, respectively, and the Fed funds rate is expected to hit 3.25% at the end of 2019, so the cycle should last 2+ more years.
How will oil's slide affect investors?
Crude prices have fallen nearly 30% since early October, as surging US and Russian production and US concessions on Iranian exports have raised concerns over excess global supply. But we believe oil is set for a swift rebound. Global oil supplies will still be hit by US sanctions on Iran, and Saudi Arabia has indicated its readiness to cut output. As oil prices recover, we expect energy equities, which have been underperforming, to rally.
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The resumption of US sanctions is expected to cut Iranian oil exports to less than 1 million barrels per day (mbpd), from a recent average of 2–2.5mbpd.
Oil-producing nations in both Africa and the Middle East have benefited from the rise in oil prices over the past several months. However, Industry Leaders view this as a positive only for the short term. Governments will need to maintain discipline over their balance sheets to instill economic confidence.
Qatar said on 3 December that it would quit OPEC in January 2019 to focus on its larger role as the world's top LNG exporter. This is not a game-changer for oil, with Qatar producing just 600,000 barrels per day, compared with around 11 million from Saudi Arabia.
Can a Brexit deal be reached?
The UK's leadership has reached a withdrawal agreement with the EU, but domestic opposition to the deal remains fierce. The deal appears unlikely to pass as-is when it goes to a vote in the UK parliament on 11 December, and substantive amendments would require EU approval. With the outcome uncertain, we prefer stocks that could navigate any Brexit scenario well.
Did you know?
The proportion of UK exports going to the EU has been declining. In 2016, it was about 43%, while 54% of UK imports came from the EU.
Without a trade deal, UK exporters would face GBP 5.2bn in tariffs on goods sold to the single market, while EU exporters would face GBP 12.9bn in tariffs on the reverse trade, according to estimates by Civitas.
In a UBS Industry Leader Network survey, the majority of business leaders felt that the EU-UK economic relationship will remain largely unchanged during the Brexit transition. But some have already noticed changes in business activity, with multinationals restructuring internally and shifting orders back to local markets.
What are the real risks to the bull market?
Global stocks are enjoying their longest bull market in modern history, and the economic expansion's length will enter uncharted territory by the end of 2019. But old age doesn't kill bull markets, and neither do geopolitical crises. Recessions and bear markets are usually accompanied by overextended credit conditions or an overheating economy. Based on our Bull Market Monitor and our Global Risk Radar analysis, faster Fed tightening is the bull market's primary threat, with a low (10–20%) chance of triggering a recession in the next 18 months.
Did you know?
While the Federal no longer refers to its monetary stance as "accommodative," financial conditions remain loose, with easy access to credit for most debtors.
The misery index (the sum of US inflation and unemployment rates) is a key indicator of economic health, with a low reading indicating a supportive mix of growth and inflation. At 6.6%, the current level is among the lowest 20% of readings since 1948.
While geopolitical events often leave a lasting mark on society, the "Political flux" simulation shows that markets—and economic cycles—have proven remarkably resilient to such crises.