BlueBay AM: Growth is not dead!

BlueBay AM: Growth is not dead!

Mark Dowding, co-Head of Developed Markets at BlueBay AM, has issued his latest market insight in which he looks at the year ahead, with robust jobs data in the US and The Federal Reserve suggesting that it will be patient with monetary policy, it appears that investment opportunities will be there over the coming 12 months.

As we transitioned into 2019, it seemed that financial markets were gripped by fears of impending economic slowdown, which helped to fuel flight-to-quality trades, as markets continued to sell risk assets following on from the trend at the end of 2018. 

However, the past week has seen a reversal in the wake of robust US jobs data, which continue to highlight the ongoing strength of the US domestic economy, and Federal Reserve (Fed) comments alluding to its ability to be patient as monetary policy adopts a more data-dependent path. 

Following some wider swings in markets and plenty of hyperbole, it feels like an appropriate juncture to take stock of where we stand, as we assess the outlook for the year ahead and identify where we see the strongest investment opportunities.

What’s to come

Starting with the US economy, we continue to expect growth at an above-trend pace, with GDP expansion set to exceed 2.5%. Our confidence is based on the outlook for the US consumer. 

Consumption is the dominant part of the US economy and, at a time when job growth, wage growth and lower taxes are all driving up disposable incomes, we feel that domestic trends can remain robust. We would highlight that the Atlanta Fed GDP Nowcast currently stands at 2.8%, and that with the exception of the new orders component of the recent ISM survey, we feel US data has been robust. 

Inflationary pressures remain relative muted, though core CPI around 2.2% is broadly in line with the Fed’s mandate and we believe inflation is unlikely to fall if domestic growth remains robust and wages are rising. 

In addition, we would continue to assert that policy remains relatively accommodative and is growth supportive. 

Although there was tightening in financial conditions during the past year, this has been reversing as markets have stabilised and we feel that there has been a lot of mis-reporting of the implications of the inverting of the US yield curve, to which we would attribute little economic impact – save for seeing an uptick in mortgage demand as consumers book gains by refinancing at lower rates.

Looking east

By way of contrast, growth momentum in China continues to slow, with an ongoing slump in auto sales only adding to worries related to a hard landing. A sharp drop in PPI data to 0.9% (from 4.5% in the middle of last year) implies a material slowing in nominal GDP growth, which is also supported by recent PMI data. 

Some policy easing has been delivered and more is sure to follow, yet deleveraging remains an ongoing theme and although recent trade headlines have provided some solace, we suspect that this may be more of a temporary cease fire than an end to the trade conflict.

Recent meetings with policy makers across the G7 continue to highlight mounting concerns related to Chinese hacking, data security and IP theft, and it has been noticeable how policy makers across developed markets are seeking to limit Chinese access to 5G technologies within developed markets. 

All of this suggests to us that we should look for divergent growth trends to remain a theme in the year ahead. 

In our view, if China downside risks can be contained then there is no reason not to believe that the Fed will continue to hike rates two or three times in 2019. Recent Fed minutes and comments from Powell and other Fed speakers suggest a patient approach and this is entirely understandable given moves in financial markets during the past couple of months. 

However, March remains a long way away and if the US economy can continue to defy the bearish projections that many seem to have adopted, then this suggests that positive earnings growth can support equities and there is no reason why another rate hike in Q1 should not remain on the cards. 

This will hinge on the economic data – yet we would seek to emphasise that less has changed in the economic outlook than has shifted in financial markets in the past couple of months – and it does interest us how some investors can be sucked into looking for a convenient narrative to fit to price action, leading them to conclude that growth must have slowed substantially when we would contend that it has not.

A shift in Europe

Economic sentiment in Europe has also become very bearish of late. However, we suspect that downside fears on this side of the Atlantic are also overplayed. 

Eurozone unemployment dropped to a new cycle low of 7.9% this week and it seems that underlying domestic trends remain more supportive – even if external demand has dragged down growth; notably in Q3 when a German auto shutdown led to a sharp drop in manufacturing data.

With evidence that fiscal austerity has given way to fiscal easing in a number of eurozone countries, we believe a likely growth outcome of around 1.4% in 2018 should be mirrored in the year ahead and that all may not be as bad as it may seem. 

In contrast to the US, we see core inflation in the eurozone remaining stubbornly low and likely to be below 1% in the year ahead. This should keep monetary policy relatively easy and we would look for an LTRO supplement to be announced by the European Central Bank (ECB) in March, with no moves in interest rates likely in the year ahead. 

Meanwhile, we feel that tensions in the periphery can fade with Italian risks mitigated for the time being. 

A cast of grey in the UK

The economic backdrop for the UK continues to be overshadowed by Brexit, and with the clock continuing to tick down towards 29 March, there remains no real clarity with respect to the final outcome. 

We expect Theresa May’s Withdrawal Agreement to fail in Parliament and for this to lead to debate with respect to an array of alternatives.

There remains a majority opposed to a hard Brexit in the absence of any deal, yet if nothing is agreed then this remains the default situation and, consequently, we continue to believe that there will need to be a moment in the coming weeks where the UK stares over this potential cliff-edge before taking a different path. 

Ultimately, we believe another referendum, or a general election, are the most likely scenarios. In the short term we remain bearish on the pound, but it is possible that it will rally after the cliff-edge is dealt with.

Meanwhile, we feel strongly that Gilt yields should rise under pretty much every Brexit scenario as we believe that fiscal easing will become the policy alternative of choice to counter any economic weakness in the wake of Brexit.

Global growth vs technicals

We remain relatively cautious on corporate credit spreads globally, as much due to technical concerns as due to fundamental factors.

Broadly speaking, we have a more optimistic growth outlook and we do not see a very material rise in default rates in the course of the year ahead. 

With valuations being substantially wider than this time last year, this should therefore make credit risk relatively attractive based on a more fundamental assessment. However, we feel the technical backdrop remains much more concerning.

We continue to expect heavy net issuance in a market where investors seemingly already have all the credit risk they need. This means that supply will need to be offered with a concession and this in turn should re-price spreads across the broader market.

We see credit curves continuing to steepen and an increased importance in assessing the relative supply and demand factors across different parts of the broader credit market in different jurisdictions.

EM uncertainty

The outlook in emerging markets also remains relatively mixed in our thinking. We believe that there are assets and currencies which appear attractively priced following weakness in 2018 and where fundamentals are moving in a constructive direction.

However, concerns in places such as China continue to leave us cautious with respect to embracing a more constructive view on the asset class beta. This calls for a more selective and bottom-up approach, in our view, and a need to size positions consistent with liquidity and volatility in these markets.

2019 – a year of opportunity…if the economics play out

Overall, 2019 appears to offer plenty of opportunities for active investors. Though in summarising where we find ourselves at the very beginning of the year, our overriding observation is that the most important call to be made right now is on the economic cycle, where we simply feel that markets are currently failing to process the fact that the US economy can continue to do well even at a time when the outlook for an economy like China is much more difficult.

Ultimately, we believe that rumours and suggestion with respect to the death of US growth in this cycle are as widely inaccurate as those circling with respect to the demise of Hollywood actress Olivia Newton-John this week… 

Indeed, we still feel that US growth is more likely to run ahead like ‘Greased Lightning’, much to the bear’s surprise!







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