What is the outlook for 2019?

How advisers can help clients to navigate the risks they face in 2019

Brexit and other geopolitical events have been hard to ignore in 2018 and it looks like 2019 will be no different.

Certainly, the UK's impending departure from the EU - along with the prospect of leaving without a deal in place, or having another general election before March 29 - is a worry for clients.

But there are other risks on the horizon as another year is welcomed in, including fears of a recession, potential interest rate rises and trade wars.

So what should advisers know about some of the risks client portfolios might face next year?

Read on to find out more about the chances of a recession and how to position clients for the worst.

Advisers say Brexit is clients' biggest concern for 2019

Four in five advisers believe the impact of Brexit is their clients’ top concern for the new year, according to the latest FTAdviser Talking Point poll.

The poll asked advisers to choose which of the four risks clients worry will have the biggest impact on portfolios.

A total of 79 per cent said their clients’ biggest concern was the UK’s vote to leave the EU, while 12 per cent predicted moves in interest rates.

While clients are concerned about Brexit, most advisers do not perceive it to be that significant a risk.
James Beaumont, Natixis Investment Managers

Some 5 per cent said the impact of the US-China trade war on global growth, while 4 per cent chose moves in currency rates.

Patrick Connolly, head of communications at Chase de Vere, said it was no surprise that Brexit topped concerns.

Mr Connolly said: "Some of these uncertainties arise on a fairly regular basis, such as stock market volatility, rising inflation, interest rate rises and currency fluctuations

"However, Brexit is different as we have never been through this before – nobody knows how it will play out and what the implications will be for stock markets, bond yields, inflation, interest rates, etc."

But James Beaumont, head of consulting and advisory at Natixis Investment Managers, said the result underlined some commonly held misconceptions in UK portfolios.

Mr Beaumont said: "While clients are concerned about Brexit, most advisers do not perceive it to be that significant a risk, particularly in the short term because Brexit has a most immediate impact on the pound and not equity or bond markets.

"We have not seen advisers making material changes to their portfolios due to Brexit, but as always would recommend that clients build as diversified portfolios as possible."

Paul Mumford, fund manager at Cavendish Asset Management, added that with so much noise and confusion around Brexit, investors and markets were in "a state of possible lockdown".

victoria.ticha@ft.com

CPD: What are the biggest risks for clients in 2019?

Words: Saloni Sardana
Images: Pexels

How to help position client portfolios as 2019 gets underway

With the UK’s departure from the EU due at the end of March, escalating trade wars and speculation of another financial crisis, 2019 is sure to be a defining year for financial markets.

Amid this backdrop many advisers may be wondering, what will the biggest risk be for clients in 2019?

Many financial advisers and analysts expect Brexit and its prevailing political uncertainty will be a gamechanger in 2019.

Political wrangling within the UK government and between Prime Minister Theresa May and EU leaders over Brexit has been bubbling on for months, but what specifically about Brexit is still worrying clients?

Prospects for sterling

Ricky Chan, director and chartered financial planner at IFS Wealth and Pensions, says: “It appears that even the most optimistic forecast of any version of Brexit, especially a hard Brexit or no-deal scenario, will likely lead to a recession.”

The risks that come with the prospects of a no-deal Brexit are voiced by others.

Owen Cook, independent financial adviser at Ablestoke Financial Planning, points out: “We could see a no-deal situation arise, more uncertainty and a likely weakening in sterling.”

On December 12, the Prime Minister fought off a leadership challenge from within her own party, with Conservative MPs voting 200 to 117 that she should stay in office.

Schroders’ research shows that advisers are recommending their clients move money away from the UK.
Philip Middleton, Schroders

While this, theoretically, should eliminate the risk of a no-deal Brexit, Mrs May still faces the onerous task of getting MPs to approve her withdrawal agreement.

The prospects of a no-deal Brexit are still looming, should MPs reject her deal and fail to provide an alternative solution.

“However, we are also likely to have some form of ‘deal’ meaning a possible strengthening in sterling, leading to a falling UK stock market,” Mr Cook cautions.

A weaker pound is, in fact, a positive driver of growth for FTSE 100 companies as those in the index derive the greater part of their earnings from overseas.

Tactical asset allocation

Many analysts advise clients to steer away from UK equities because of sterling’s vulnerability to Brexit volatility.

Philip Middleton, head of UK intermediary at Schroders, says: “Schroders’ research shows that advisers are recommending their clients move money away from the UK and into global and mixed investment assets.”

“Highlighting this, the US market saw the biggest investment inflows in 2018,” he adds.

While Mr Middleton says clients are advised to invest in other global equities, he also stresses that financial advisers are still expecting allocations to UK equities to edge up in the next 12 months.

Mr Chan suggests: “Some may favour tactical asset allocation tweaks to reduce exposure in UK equities.”

Alan McIntosh, chief investment strategist at Quilter Cheviot Investment Management, says all global equities could suffer, not just UK stocks.

“We saw global equities perform poorly in 2011 and 2015, for example – and risks around trade, monetary policy and Chinese growth could weigh on sentiment over the coming year,” he observes.

Inverted yield curve

Many experts predict that the US is due a recession – if it were to happen, it would be an economic event that would reverberate around the world, potentially impacting other financial markets and marking the end of a decade long bull market.

Mihir Kapadia, chief executive of Sun Global Investments, says: ”There is a heightened risk of recession in 2019, though historical patterns suggest that it may come in 2020.

“Looking at the yield curve for US Treasuries, the yield spread between two-year and 10-year US Treasuries fell to its lowest in 11 years, to 14 basis points (bps) or 0.14 per cent in December.”

The flattening of the curve this year is in line with our view of a weaker economy in the second half of 2019.
Chris Iggo, Axa Investment Managers

Why should this alarm investors?

An inverted yield curve has been a bellwether for predicting every economic recession since World War Two.

The curve shows the return on yield for bonds with different maturities.

Chris Iggo, chief investment officer, fixed income at Axa Investment Managers, acknowledges no end of people have pointed out that every recession in recent decades has been preceded by a flattening of the US yield curve.

“That is not in contention and the flattening of the curve this year is in line with our view of a weaker economy in the second half of 2019 and going into the US presidential election year of 2020,” he says.

He points out that in the week commencing December 3, five-year Treasury yields fell below two-year yields for the first time since 2005.

“This got a lot of coverage on the ‘hysteria channels’ and arguably led to the violent sell-off in bank stocks that took the S&P 500 index down over 3 per cent on Tuesday, December 4,” he explains.

“So, the sequencing for the bear is, yield curve inverts, stocks tumble, confidence falls, real economic decision making becomes more cautious, the data weakens as a result and stocks fall further, causing interest rate expectations to decline and the yield curve to invert more.”

Not on the doorstep

Seema Shah, senior global investment strategist at Principal Global Investors, observes: “The inversion of parts of the Treasury yield curve is a concern.

“But, while yield curve inversion is undoubtedly an indicator of market stress, it doesn’t mean recession is at the doorstep.”

Mr McIntosh thinks while a recession is imminent, he agrees it may come a bit later than expected.

He warns: “The main concern in markets at the moment is that the US Federal Reserve may raise rates too high for the economy, and that as the effect of fiscal stimulus fades in 2019, this will be enough to push the US into a recession in early 2020.”

I still favour equities and feel there is still a few more years of growth before any true recession may kick in.
Owen Cook, Ablestoke Financial Planning

While Schroders’ chief economist, Keith Wade, does not expect a global recession he still expects global growth to slow to 2.9 per cent in 2019.

“I would caution, however, that the yield curve signals a recession 12 to 18 months out. That, combined with current economic data, makes me think that if we do see growth turn negative, it will come at the end of 2019 at the earliest,” predicts Mr McIntosh.

David Lafferty, chief market strategist at Natixis Investment Managers, agrees that the recession may come post-2019.

“We do not yet see a US or global recession for next year as consumption is supported by strong employment trends in many countries, but the possibility cannot be ruled out,” he explains.

Mr Lafferty adds: “As the result of two more Fed hikes at the short end and somewhat lower rates further out the maturity spectrum, we expect the US yield curve to go completely flat or invert slightly.

“This process will bring more calls of recession for 2020.”

Central bank warning

UK interest rates will also come under the spotlight in the run-up to the UK’s departure from the EU.

The Bank of England (BoE) raised interest rates from 0.5 per cent to 0.75 per cent in August 2018.

Whether the BoE raises interest rates further or not is likely to depend on the state of the UK’s economy once it has left the EU.

A potential interest rate hike will have ramifications for several sectors, particularly the property market.

Daniel Hegarty, founder and chief executive of online digital mortgage broker Habito, says: “The biggest risk for clients in 2019 is not making a decision on buying, selling or refinancing their home while they wait for Brexit and other political uncertainty to settle over the coming year.”

Mr Hegarty adds: “We've observed an increase in longer-term fixed mortgages and we expect this trend, which many are calling 'Brexit insurance', to continue in 2019.

“There may also be space for innovation in even longer-dated mortgages like 10, even 15-year, fixed rate mortgages.”

From an investment point of view, Mr Cook says: “[Clients should] avoid UK commercial property as Brexit is undecided as of yet, thus [it is] better to err on the side of caution.

“I still favour equities and feel there is still a few more years of growth before any true recession may kick in.”

Emerging markets could become the best performing asset class overall in 2019.
Mihir Kapadia, Sun Global Investments

In November 2018, BoE governor Mark Carney said a “disorderly Brexit scenario” could knock as much as 30 per cent off house prices and could see commercial property prices fall 48 per cent.

Mr Carney also stressed GDP would shrink by 8 per cent in 2019 in the event of a no-deal Brexit.

Mr Chan says: “Commercial property could be hit hard – particularly as businesses fold/struggle to keep up with rent payments, or leave the UK post-Brexit – and this is underlined by [Mr] Carney’s recent Brexit forecasts suggesting that it could fall by 48 per cent in a disorderly [Brexit] scenario.”

Silver lining for emerging markets?

Amid much of the Brexit uncertainty and global hawkish stance, experts say clients who invest in emerging markets may be hedged against many of these risks.

Mr Kapadia says: “Emerging markets could become the best performing asset class overall in 2019. However, there will remain a high degree of risk as global markets will be sensitive to the negative sentiment of trade wars.

“With the growth outlook in the eurozone and the US subdued, stock and bond markets are likely to face significant headwinds.”

He explains clients who invested in emerging markets in the current year may have suffered because of weakness in key emerging market currencies.

But fears of a US recession means the dollar could depreciate, a factor that is supportive for emerging markets.

Emerging markets typically borrow money in US dollars, so a weaker dollar strengthens their currencies and can reduce the size of their debt.

The Turkish lira fell to a low of 0.15 against the dollar in August 2018, and has recovered slightly since.

China, the world’s largest emerging market, generated headlines this year due to escalating trade tensions with the US.

Mr McIntosh says: “It’s possible we see a relief rally in one of this year’s poorer performing markets - emerging market equities, for example - particularly if China resorts to further stimulation of its economy.”

The President Donald Trump administration had imposed tariffs on $50bn of goods coming in from China in June 2018 and threatened to impose tariffs on an additional $200bn worth of goods.

Both countries reached an apparent truce earlier this month.

Mr Kapadia says: “Safe havens, such as gold, also become of particular interest with news about Brexit shaking the markets on a daily basis and investors could do well with a slight increase in exposures there.”

saloni.sardana@ft.com

House View: Outlook 2019 - Global economy

The world economy continues to expand but there are signs that growth has peaked as the US, European and Asian economies slow. We expect trade tensions between the US and China to persist well into next year with higher tariffs creating a more stagflationary environment of lower growth and higher inflation.

Global GDP growth to slow

Our forecast is for global economic growth to slow to 2.9 per cent in 2019 from an estimated 3.3 per cent in 2018. This is below consensus (3.1 per cent) and largely reflects our more pessimistic view on the US.

We see US GDP growth at 2.4 per cent in 2019, as the boost from tax cuts fades while interest rates move higher and the effects of a prolonged trade war with China are felt.

While the recent 90-day truce is welcome, we remain sceptical on the prospects for a longer-term agreement on issues such as intellectual property rights. We see a further slowdown in global growth to 2.5 per cent for 2020.

The picture in emerging markets is mixed, with China and the wider Asian economies under pressure from trade tensions.
Keith Wade, Schroders

In the eurozone, we forecast growth to slow further in the first half of 2019 due to the effects of the trade war between the US and China. Our forecast has GDP growth slowing from 1.9 per cent in 2018 to 1.6 per cent in 2019. Assuming Brexit goes smoothly, the UK should see an improvement in growth in 2019; we forecast GDP growth of 1.4 per cent.

For Japan, we see GDP growth of 1 per cent in 2019, little changed from 2018. The start of the year looks set to be robust, helped by reconstruction spending after the damaging earthquakes, floods and typhoons of 2018. However, VAT is due to rise to 10 per cent from 8 per cent in October and previous VAT hikes have had a significant impact on economic activity.

The picture in emerging markets is mixed, with China and the wider Asian economies under pressure from trade tensions and lower demand in the technology sector.

We forecast Chinese growth to slow to 6.2 per cent in 2019 from 6.6 per cent in 2018. Latin America may be a bright spot within the emerging markets as Brazil’s economy looks set to strengthen now the elections are over.

Inflation on the up, driven by emerging markets

Despite cooler economic growth and lower oil prices, our global inflation forecast has increased to 2.9 per cent for 2019. This is a result of higher inflation in the emerging markets, where currency weakness is pushing up import prices.

In the advanced economies, we have trimmed our inflation forecast as a result of downgrades to Japan and the UK.

For Japan, the lower forecast includes special factors such as a 20 per cent cut in mobile phone charges.

For the UK, we forecast inflation to fall from 2.5 per cent in 2018 to 1.8 per cent in 2019. This is due to softer oil prices as well as expectations that sterling will strengthen against most currencies in the event of an orderly Brexit.

For the US, we see inflation remaining elevated in 2019 at 2.7 per cent. Our projection reflects the tighter capacity typical of this late stage in the economic cycle as well as higher import tariffs as the trade war continues.

US rates to peak in mid-2019

We anticipate three more interest rate increases from the US Federal Reserve (Fed), taking the Fed funds policy rate to a peak of 3 per cent in June 2019. We assume that the Fed will “look through” above-target inflation in 2019 and will pause to take account of the effects of slower growth on future price rises.

We then expect rate cuts in 2020 as the US economy cools further.

For the Bank of England, we look for two rate rises next year, although this is dependent on a smooth exit from the EU with a transition period for the economy.

We expect the combination of a peak in US rates and the start of tighter monetary policy elsewhere to result in a weaker US dollar in 2019.
Keith Wade, Schroders

Meanwhile, the European Central Bank (ECB) is expected to end its asset purchase programme in January 2019 and to raise interest rates in September.

This would be the first increase during ECB President Mario Draghi's tenure and would also be his last given he steps down from the post in October.

Although eurozone growth is expected to be weaker next year, it will still be above trend and sufficient for a central bank keen to start raising interest rates from ultra-low levels.

• For more on the longer-term outlook for growth, inflation and other economic forces, please see our Inescapable investment truths for the decade ahead.

Weaker dollar could be silver lining for emerging markets

We expect the combination of a peak in US rates and the start of tighter monetary policy elsewhere to result in a weaker US dollar in 2019.

Although the difference between US interest rates and those elsewhere will remain in favour of the US, currency markets are likely to have priced this in already. We think currency markets will increasingly focus on the growing budget and current account deficits in the US, which will drag the currency lower.

The current account is a nation’s transactions with the rest of the world, including net trade.

For the emerging markets, a weaker dollar could be the silver lining in the outlook. Although an escalation of the trade wars and the prospect of slower global growth does not bode well, a weaker dollar would help ease pressure on the region.

In 2018, rising US interest rates and a stronger dollar squeezed dollar borrowers outside the US, put pressure on emerging market currencies and forced local central banks to tighten monetary policy.

There is a strong possibility that the ECB has left it too late to normalise interest rates
Keith Wade, Schroders

Dollar strength also weakened commodity prices and hurt world trade.

In 2019, there is scope for some of these factors to unwind, thereby easing financial conditions and supporting emerging market assets.

For the eurozone this scenario is less favourable as a stronger euro will tighten financial conditions, while the slowdown in the US is dragging on global growth. Both factors make it harder for the ECB to keep raising interest rates.

There is a strong possibility that the ECB has left it too late to normalise interest rates and will look back on the past year as a missed opportunity.

The region could become stuck with low rates and with little monetary firepower to fight the next downturn.

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change.

We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts.

Forecasts and assumptions may be affected by external economic or other factors. The opinions/forecasted views above should not be construed as advice or recommendation.

Keith Wade is chief economist and strategist at Schroders