What do the financial markets have in store for 2019?

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Filip, last year you warned that 2018 would be more turbulent after the exceptionally good year for the stock market in 2017. Were your predictions correct?

Partly yes. Economic activity reached its peak towards the end of 2017, and declined slightly in the course of 2018. This slowing was noticeable mainly in the eurozone and the emerging markets. In the US we did not yet see that slowdown in 2018. This was due to the fiscal reforms by President Trump, which further fuelled the economy. Nevertheless, globally all asset classes recorded negative returns in 2018. And that had not happened in 30 years.

The rising volatility in 2018 caused falling stock markets. A rise in US interest rates, together with the first signs of a slowdown in growth, resulted in a first wave of selling on the market, causing stock market corrections of up to 20%.

What does 2019 have in store?

Overall, we expect the growth slowdown to continue in the eurozone and the emerging markets. The slowdown will also occur in the US. Trump was able to delay it for another year, but in 2019 the positive effects of his fiscal measures will disappear.

Other predictive indicators also point to a continuation of this decline in 2019. For example, we can see that worldwide orders and trade volume will decrease further in the coming months. Global trade will also go on weakening.

Moreover, we must take into account the geopolitical situation, although it’s like reading the tea leaves. So far we’ve seen few consequences of the possible trade war between China and the US. And at this moment in time, it seems more likely that the US and China will reach an agreement. We don’t yet know whether Brexit will be hard or soft, which makes its impact uncertain. The potential impact for Europe will however be limited, as only 2% of European exports go to the United Kingdom. But 7% of Belgium’s exports go to the UK so a hard Brexit may hit 'harder'.

Do you again see different scenarios in 2019 from region to region?

In the eurozone we experienced a peak in economic growth at year-end 2017. From 2018 the data showed a slightly decreasing trend. For example, industrial production fell by 1%. The services sector still remained buoyant, while consumer spending rose by 1% compared with 3% in 2017.

Consumption remained stable in the US in 2018, but there too we are now seeing the first signs of cooling. The US has been growing for 115 months in a row. The longest-ever period was 118 months between 1991 and 2001. You can notice there that we are approaching the end of an economic cycle. The output gap, or the difference between the actual size of the economy and how big an economy can become according to the central banks, has turned positive as a result of the tax reforms. This 'overheating' can last for a while yet, but not for years. Finally, the interest rate curve, or the difference between long-term and short-term rates, is becoming flatter, heading towards zero. Historically, this has always been a negative indicator for the evolution of the economy.

We also see the slowdown in growth in the emerging markets. In China, industrial production growth has dropped from 6% to 5.5%. The impact of an impending trade war has dampened sentiment, because exports from China are also beginning to decline. We additionally see rising debt, especially among state enterprises, local authorities and families. This increase in debt cannot continue at this rate, which ultimately must lead to a slowdown in growth.

Belgium is doing pretty well all in all. The debt ratio is high, but on average Belgians have more investments abroad than foreigners have in Belgium. That makes our economy less dependent on foreign lenders at times of crisis. Unemployment is far more stable than in the rest of the eurozone, but wage costs remain high and affect our competitiveness. Belgium must continue to keep a watch on the general government deficit and continue its efforts.

What are you forecasts for the different asset classes?

If we start with government bonds, you can see that the cooling of the economy also limits the upside potential of the linear bonds. With 10-year bonds, Italy remains the problem child. Nonetheless, a government bond remains a safe choice in volatile times.

As regards corporate bonds, the BBB bonds  are once again becoming an interesting path after the correction at the end of last year. We remain negative about High Yield bonds (bonds of lower credit quality) or bonds of emerging countries, because the underlying risk is too high in relation to the extra return.

Finally, on the stock market, American shares are still fairly expensive compared with the other regions. For opportunities it is better to look at the emerging markets, provided that you accept the interim market fluctuations. European shares are more correctly valued. In general, it will remain necessary in 2019 to keep an eye on the increased volatility on the stock markets.

Is this slowdown of growth mainly due to emotionality? Or is there something wrong with the basic fundamentals?

It is a combination of the two, but by year-end 2018 emotion seemed to gain the upper hand, which led to exaggerations on the markets. The uncertainty surrounding a trade war and Brexit has an adverse effect, causing companies to postpone investments. This speeds up the cooldown. But even without the emotional side, the decline would still occur because the economic expansion has been going on for a long time. An additional factor is unemployment, which is very low in the US and in the eurozone. Wages then increase more strongly, thus reducing company margins and shrinking profits. So an economic cooldown is only logical.

Are we heading for a recession?

Even though a recession is inevitable after a certain period of time and even healthy, it is unlikely to happen in 2019. As the largest economy the US remains the most important driver. We are only seeing a cooldown there at present, not yet a stagnation of growth.

The most important factor remains the central banks, and that is nothing new. While in 2018 they were all talking about stricter monetary policy, with less support of the economy and, indirectly, the financial markets, they appear to be pressing the pause button for 2019 and waiting for the economic growth figures. This stance on the part of the central banks has calmed investors and made the markets rise since Christmas.