Looking ahead - a UK investor's perspective

Video transcript

David Page talks about what UK investors can expect from the markets in the year ahead.

Global financial markets expecting softer, slower growth.

Global financial markets began 2018 in relatively high beat. The growth backdrop for 2018 has been relatively firm. We’ve seen the fastest expansion in the global economy excluding China since 2011. And that’s been driven by the US economic backdrop, which in turn has been supported by significant fiscal expansion. However, in other regions global economic activity has not been quite so firm, China, due to domestic policies, started to slow at the start of the year, and has been further exacerbated by some impact of US restrictive trade policies. This combination has also seen a spill over into eurozone economic activity, where net trade has disappointed across the course of the year, seeing eurozone growth come in a little bit softer than expected. And emerging markets have also had a relatively torrid year.

As we go into 2019, we expect to see some further modest deceleration across the course of this year. We expect global growth to slow to 3.6% from 3.8%. And we expect to see some slowdown being led by the US, where the fiscal boost of 2018 is set to fade, and tighter financial conditions and some impact of the restrictive trade policies is likely to weigh. But those restrictive trade policies are likely to have more of an impact across the course of China, and that could also impact emerging markets; although for the eurozone we expect relatively solid domestic demand to see only modest deceleration there.

The course of 2019 is set to see deceleration in most economies, even though we see emerging markets hold firm, but we think that the deceleration next year should only be modest.

As we go into 2020 though the outlook starts to darken a little bit. We see material deceleration in the US economy, driven not least by the restrictive trade policies, but also by an ongoing tightening in financial conditions, and we think that China, although macro policies have eased significantly recently, will also face some ongoing headwinds, which will also spill over to the rest of the world. We see a more marked deceleration in global economic activity and we see growth slowing to 3.5% in 2020. However, the risks of a contraction we think are not likely over the next couple of years, but markets will keep a very close watch on that.

A smooth Brexit?

Turning to the UK, the United Kingdom and the EU have, after 18 months or so of negotiations, finally brought together a withdrawal agreement. That’s a legally binding document which dictates the terms of the UK’s exit and importantly includes a transitional arrangement which should last for at least 21 months, but is likely to last significantly longer than that. There’s also a protocol declaration, a non-binding declaration which sets out the future terms of the EU’s relationship with the UK. However, it’s not clear at the time of recording how the political declaration, nor the withdrawal agreement, will fare in domestic politics in the UK.

At this stage we still think there’s a good chance that the UK will ultimately support this withdrawal agreement, and that will see a transitional Brexit. This transitional Brexit, a smooth Brexit, would allow we think for the UK to see some pickup in economic activity. Business investment is likely to resume, consumer confidence and consumer sentiment is likely to be buoyed by an increase in real incomes, and the chancellor’s even set out some loosening of the public purse strings to allow further fiscal stimulus. All of this should help the UK pick up from what’s been one of the weakest sets of growth in 2018 for nine years, at 1.3%, and we expect growth to pick up to 1.8% in both 2019 and 2020.

Against that backdrop the Bank of England is likely to find itself, quickly after Brexit uncertainty fades, back on the tightening phase, and we expect the Monetary Policy Committee to be tightening monetary policy at a faster rate than seen in recent years. We expect four hikes starting in May 2019, taking us through until August 2020, taking Bank Rate to 1.75%. However, as we’ve said, there’s significant political uncertainty surrounding the acceptance of this Brexit withdrawal deal and therefore the transitional arrangements that go with it. If the UK were to face an abrupt withdrawal in the short term, this would deliver an unprecedented supply side shock to the UK economy, which we think would certainly lead to recession in the UK across the course of 2019.

The stark consequences of a ‘no deal’ and abrupt exit are in themselves good reason why the UK would seek to avoid that. And there are alternatives. We may yet see a no deal that leaves the EU on a more managed basis. We could even see a second referendum, and some hopes to reverse Brexit. However, our central expectation is that the UK ultimately supports a deal very close to what Theresa May has managed to deliver with the EU, and that forms the basis of our expectations for faster growth across the course of next year.

A UK investor’s perspective

From a UK investor’s point of view, 2019 and 2020 are going to have a number of issues to grapple with.

On a global basis we expect to see a modest slowdown beginning in 2019. And the modest slowdown with growth continuing at a reasonable above trend pace for the global economy, should support risk assets despite some of the selloffs that we saw in financial markets at the backend of 2018. That should allow risk performance markets to do relatively well, but we also expect central banks to continue to withdraw monetary policy, or at least to provide less stimulus. And that’s likely to see duration assets underperform.

As we look into 2020, however, the economic outlook clouds. We do expect material deceleration coming through from the US economy, and we think that’s likely to see global economic activity dip lower. Against that backdrop, as financial markets look at the back end of the 2019 into what looks like a more uncertain 2020, we start to expect to see some underperformance come through in risk assets. So 2019 threatens to be a year defined by two halves.

But from a UK investor performance we also have to overlay the outlook for Brexit as well. The Brexit uncertainty continues to dominate financial markets, and will dictate the economic performance of the UK over the next few years.

Our outlook is relatively optimistic in that we see a transitional exit. One that’s supported broadly by the deal that Theresa May has negotiated for now. And that should support UK assets. Indeed we would envisage seeing UK assets do relatively well in this environment, led by a pickup in sterling, and seeing UK gilt yields rise as well. However, if we see a worst case scenario, an abrupt exit from the EU coming as soon as March next year, then we see a significant shock being delivered. From that instance, and because of the political uncertainty that surrounds that, there’s going to be a significant degree of volatility that surrounds UK assets as we trade in the early few months of 2019, before a clearer picture begins to emerge.

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