08th January 2019
2019 International: Will the Rest of the World Awaken?
Last year was anything but traditional for international investors. Can a new year bring new hope?
If you had to sum up the rationale for the underperformance of most foreign markets from the dollar-based perspective of a U.S. investor, economic growth, currency movements, and trade talk uncertainties would be the three most influential headwinds. Simply put, U.S. economic growth surprised on the upside whilst other major economies did not, the dollar appreciated against most other currencies, and concerns about essential future trading relations impacted the more export-focused European and emerging markets last year. In order for international markets to gain momentum over the U.S. in 2019, these concerns need to be quelled.
Economic growth and trade policy are inevitably and deeply integrated, as even a cursory glance at the economic history of the 1930s and 1970s illustrates. The more conciliatory signs from the recent G20 discussions in Buenos Aires suggest a hopeful position on global trade should be adopted in 2019, as all sides fear the impact of a vicious cycle of additional protectionism and lower growth rates. After all, the easiest way to induce something which feels like a global synchronised recession is to shift global trade trends into a sharp reversal. However, significant ongoing discussions are still required, and the world trade discussions are just one piece of the economic growth story.
Hope on the Horizon?
Progress is most visible in China where policymakers continue to have significant room to manoeuvre, a luxury not afforded by most other economies around the world. This flexibility has been demonstrated through targeted loosening of monetary and fiscal policy and an ongoing internal reform effort focused on shifting the Chinese economy towards the expansion of consumption. Collectively, these efforts – along with the development and open access to bond markets - should allow the Chinese economy to continue to experience decent economic growth rates in 2019, especially if they bend with the wind on the trade front.
A clear rationale exists for China and the U.S. not to blow up current fluid commerce flows – after all, the President’s best bet to get re-elected is via a strong economy, whilst the Chinese want a stable external environment in order to get on with their essential domestic economic reforms. In the same vein as President Xi’s famous 2017 Davos speech, China gets material value from its World Trade Organisation membership. Noise around intellectual property shifts and market access changes are in line with the maturing of this membership and helpful to a calmer world trade backdrop. It also aids in deeper political and economic power shifts China is undertaking, such as the Belt and Road initiative, which stretches deep into Western Europe and Africa. Despite the difficult timing of a certain well-publicised arrest in Canada, I am heartened to read recent reports about good progress in the initial discussions of the 90-day negotiation period.
If some policy flexibility is apparent in China, Europe seems to be more fixated on binary choices, although the reality is much more complex than that. On Brexit, following the June 2016 referendum result where the U.K. chose to leave the European Union, a deal was struck between the two sides, but new challenges emerged in the ratification of the deal by the U.K. Parliament. Whilst details are being discussed, faith in the immediate prospects for the U.K. economy withers.
This has put the U.K. government in a difficult position. They managed to reach a compromise proposal on Brexit with the rest of the European Union but initial efforts to get this ratified failed miserably via a combination of strict pro-Brexit beliefs or opposition political expediency (with the aim of forcing a General Election). Attempts to walk a political tightrope has resulted broadly in political and legislative prevarication and a resulting lack of clarity for both consumers and businesses.
Dig deeper, however, and the spectre of the U.K. breaking away from the European Union does not seem likely. A clear majority in both Parliament and in recent general population voter polling is in favour of a more compromise-style approach, or a ‘soft Brexit’ as it has been dubbed. Expect lots of political noise, including talk about a second referendum or a general election and ultimately a thick slice of common sense to permeate the Brexit debate, quite possibly via a delay to the current Brexit timetable. Any positive moves in this broad area would likely support both the British Pound and U.K. domestic financial assets after a difficult last couple of years.
Meanwhile, outside of the Brexit debacle, pan-European market participants are deeply focused on the ongoing saga of the Italian budgetary debate, which pitches the wishes of a populist Italian government to spend more money against a more financially-orthodox European regional leadership. Typically, this does nothing but cause more uncertainty around the future path of local growth rates. Followers of the European Union decision-making process get familiar quite quickly with an abundance of “late-in-the-day” negotiations, so recent noise around more flexibility in the Italian budget is not surprising and the tentative deal struck in late December is a positive.
If both the Chinese and pan-European markets surprise fund managers from a sentiment standpoint, then the story will likely change. The chances of the Pound, euro and Chinese yuan appreciating against the dollar becomes much more likely, countering the third observation which beleaguered global markets last year: a rising dollar.
A stronger dollar is good news for U.S. travellers, but it has delayed global reform and altered initiatives in Europe and Japan. This has also resulted in strife in broader emerging markets (most notably in countries such as Turkey) due to the extensive amounts of outstanding dollar-denominated debt.
A weaker dollar and reduced trade angst, aligned with less fear toward important global economies such as China, the U.K. and Continental Europe would be particularly helpful to emerging markets in 2019. Whilst emerging markets collectively contain a multitude of challenges and influences, as a broad asset class, it appears to be in the strongest position to spring a positive surprise in 2019 relative to other non-U.S. assets.
Certainly, the actions of new political leaders in both Mexico and Brazil will be watched carefully, but a world that avoids a plunge into trade angst should see the supportive tailwinds of a weaker dollar, higher commodity prices and improved underlying growth trends. Emerging markets, after all, still retain all the structural forces they are famous for, including population growth, urbanisation, the rise of the middle class, and consumption catch-up capabilities.
In short, as long as global trade talks stay on track, the outlook for markets outside the United States for 2019 looks a lot better than it currently feels, even if we have to rely on leading global politicians to help deliver it.