A focus on quality as volatility persists
The risks of a prolonged U.S.-China trade standoff have increased, but we believe long-term fundamentals in emerging markets will offer opportunities.
Activity in segments of the global economy moderated throughout the first quarter of 2019 as policy risks and decelerating trade continued to hamper growth. The overall sluggish pace of economic expansion, particularly in the eurozone, has led us to recast our global growth forecast. However, we believe headway on a number of key issues could lead to a rebound later this year.
We have revised our global gross domestic product (GDP) growth forecast to 3.3%, down slightly from our outlook as the year began. While we project U.S. growth around 2.5%, the waning effect of tax cuts and fiscal stimulus, the trade dispute between the U.S. and China and tighter monetary policy by the Federal Reserve (Fed) continues to weigh on economic activity.
The ongoing trade standoff between the world’s two largest economies has been a drain on both and each wants a resolution. We believe a new trade agreement between the U.S. and China will be announced in the next few months, especially as President Donald Trump eyes reelection next year.
The Fed indicated it will likely leave rates unchanged this year because of weaker global growth and tepid inflationary pressure. In a surprising move, Fed Chairman Jerome Powell also announced plans to halt the Fed’s program of reducing bonds and mortgage-backed securities holdings on its balance sheet in September. These actions could help minimize a more meaningful slowing in U.S. economic growth.
The yield curve has continued to flatten in the U.S., with portions of the curve already slightly inverted. While an inversion in the yield curve has been a precursor to every modern-era recession, this is just one indicator of economic trajectory. We do not see a downturn in the U.S. economy on the horizon.
Eurozone GDP performance has been surprisingly poor so far in 2019, although it already had been weakened by the general slowdown in global growth and ongoing trade burdens. A number of local issues, including the lack of a plan for the U.K. to leave the European Union (EU), growing unrest in France over fuel taxes and rising prices generally, and the lagging effects of government mandates on automobiles in Germany have stymied growth in the region. The European Central Bank’s (ECB) response to this weakness has been to delay its plans to raise interest rates from the third quarter of 2019 to early 2020 and to add a new round of liquidity to the banking system. The lackluster economic performance in the first quarter prompted us to downgrade our 2019 eurozone GDP forecast to 1.2%.
Source: Ivy Investments. Chart shows Ivy 2018, 2019 forecasts of annual gross domestic product growth, all based on purchasing power parity. Past performance is not a guarantee of future results. The gross domestic product growth forecasts are current through April 2019, and subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
Nearly three years after the U.K.’s initial referendum, Brexit has become a political quagmire and a drag on its economy. The U.K. Parliament through early April had failed to pass a withdrawal agreement despite three attempts, leaving an already wounded Prime Minister Theresa May in further political limbo as momentum to reevaluate the “divorce” has grown.
While we continue to believe the U.K. will ultimately leave the EU with agreements that keep the two somewhat connected on key issues, the possibility of a “hard Brexit” — where the U.K. leaves the EU without a deal to clarify trade, its status with the Republic of Ireland and other issues — cannot be ruled out. Parliament’s failure to pass any Brexit legislation suggests the odds of calls for early elections have increased. We believe the thought of a change in government — especially one led by Jeremy Corbyn, the far-left leader of the Labour Party — and the increasing likelihood that the departure deadline could be significantly extended is likely to send jitters through the markets.
In our view, it is highly likely that the U.K. will fall into recession if a hard Brexit becomes reality. Such a result could send negative repercussions throughout the EU.
After battling through multiple headwinds in 2018 that spilled over into the first quarter of this year, emerging markets appear ripe for improvement. Along with its trade turmoil with the U.S., China has felt pressures from its decision to reduce the pace of debt accumulation in the economy. The deceleration in economic growth has caused the government to introduce fiscal stimulus, including infrastructure spending, tax cuts and stronger credit growth.
In addition, China’s property market recently has shown signs of weakness, but cities continue to move away from purchase restrictions, which we think will limit downside risks in the sector. We continue to believe that looser policy and the potential for a trade deal with the U.S. could result in stronger economic growth in China in the second half of 2019.
In India, the central bank recently reduced interest rates in response to slower growth. The upcoming presidential election will determine whether the coalition government of Prime Minister Narendra Modi can earn another term, which we believe could be a key factor in India’s long-term growth potential.
Following a record-setting recession, Brazil is showing signs of recovery as markets have strengthened in anticipation of pension reform, one of several fiscal reforms championed by new president, Jair Bolsonaro. While the legislation still faces an uphill battle to gain lawmakers’ approval, we believe pension reform could be passed sometime later this year.
Currency markets were mixed in the first quarter, with the U.S. dollar modestly stronger on average. The dollar’s strength came despite the Fed’s revised position on rate hikes for the remainder of 2019. While a lack of support from higher interest rates might normally be expected to undermine the dollar, the focus in currencies has shifted from interest rates to worries about global growth. That change has benefited the dollar as it tends to appreciate during times of uncertainty.
However, we expect the dollar to weaken marginally as global growth picks up throughout the year. Among developed market currencies, the pound shows potential for appreciation, assuming a Brexit accord is agreed upon in the very near term. The euro also could appreciate as growth in the eurozone begins to rebound.
The Fed’s more dovish stance on rate hikes and a weakening U.S. dollar could bode well for some emerging market currencies. We anticipate any trade agreement between the U.S. and China will include language prohibiting currency manipulation, stabilizing the yuan versus the dollar in the near term. However, we believe an uptick in economic growth in places like China and Europe will be necessary before there are any meaningful currency rallies among other emerging markets.
Risk factors: Investment return and principal value will fluctuate, and it is possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Fixed income securities are subject to interest rate risk and, as such, the net asset value of a fixed income security may fall as interest rates rise. Investing in below investment grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. Investments in real estate may be more susceptible to a single economic, regulatory, or technical occurrence than a fund that does not concentrate its investments in this industry. Debt securities, like mortgage-backed securities and asset-backed securities, are subject to additional risks due to their exposure to interest rate risk. Changes in interest rates can cause the value of these securities to be more volatile than other fixed-income securities and may magnify the effect of the rate increase on the price of such securities.
Past performance is not a guarantee of future results. The opinions expressed are those of Ivy Investment Management Company and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through April 2019, are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. This commentary is being provided as a general source of information and is not intended as a recommendation to purchase, sell, or hold any specific security or to engage in any investment strategy. Investment decisions should always be made based on an investor’s specific objectives, financial needs, risk tolerance and time horizon.