The Hatch Longread: What to expect from the markets in 2019

Everyone wants to know what’s going to happen in the markets in 2019, including us! So, we spoke to two of New Zealand’s leading financial brains to get the inside scoop on what Hatch investors should expect over the next 12 months. Jarrod Kerr, Kiwibank’s Chief Economist and Mike Shirley, Kiwibank’s Senior Trader, have many insights to share.

This is the first article of our Hatch Longreads series, which is a longer read than our usual blogs. Pull up a chair, pour yourself a coffee (or something stronger) and settle in for an informative take on the future of finance in 2019.

Hatch: In your humble opinion, what do you think is going to happen with the US economy in 2019? Will it continue to be a hellscape of ups and downs like the end of 2018 or do you think it'll come right?

Jarrod: Predicting the economy is hard enough on any given day. But throw in a leader like Trump, and, well, it gets that much harder. Trump gave the US economy an almighty sugar-rush upon election to the top job. Taxes were cut, spending was boosted. Equities soared to the moon. Now, the sugar-rush from tax cuts and spending is waning, and equity valuations have become too stretched.  2019 is going to be a particularly interesting year, and not just for the US. We expect US economic growth to continue to cool, but not crumble...yet. Trump will continue to be a major source of volatility in the world. 

Mike: Uncertainty fuels volatility and there’s a lot of uncertainty regarding the US, and as Jarrod says, most of the uncertainty levers are being pushed and pulled by Trump. We’re starting to see the fallout of the US-China trade war, with data suggesting it’s having a negative impact on both sides. Negotiations for a trade deal between US and China that would ease trade tensions are ongoing, but there is a lot of wood to chop before any serious inroads are made. The US Federal Government debt ceiling (essentially the limit of the US Government’s overdraft) poses yet another uncertainty and then there’s the current partial Federal Government shutdown. Should it drag on, it may begin to have a material impact upon the good ship US economy. We’re also heading toward the primaries for the 2020 Federal election – they come around so quickly! Uncertainty, and by extension volatility, looks set to continue. Did I mention uncertainty?

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Hatch: Pundits are predicting the worst. Are there any big financial crashes or other delightful events on the horizon? What are you watching closely in particular?

Jarrod: Are there any risks? You bet. I could name at least a dozen. But all risks basically boil down to geopolitics and populism. China is flexing its muscle as the US steps back from being a voice of reason. China is jostling for the top spot in the next decade. The entire silk road and the South China Sea are the geographical hotspots while Europe is too weak to counter either China or the US. China versus the US is shaping up to be the conflict of the next decade and it’s taking place at a time when people are fed up with the current system. Rising inequality and general dissatisfaction has led to a surge in populism not seen since the 1930s. That’s alarming. Brexit is an example of a populist vote for change. And Brexit will consume the UK and EU for potentially years to come. The PIGS of Europe still worry me (Portugal, Italy, Greece and Spain). Italy’s populist government is raging against the machine with a truck load of debt obligations. The existence of the EU itself will be continually tested, in my opinion, for the rest of my life. And if that’s not enough, the climate is changing. So what am I watching closely? US Treasury yields. US interest rates – they tell us the balance of fear in the world.  And they are still showing an awful amount fear.

Mike: Someone’s always predicting the end of the world, and for good reason – there’s only upside! If you get it right, you’re set to be quoted in the media forever as “the man/woman who predicted x event believes y event is coming”. Past returns/predictions are no guarantee of future performance/projections. Like Jarrod, I pay close attention to interest rates – they’re basically the pace car of the global financial markets. Over the past two-or-so years, we’ve seen a shift in the global rates landscape with central banks cautiously (and in the case of the Federal Reserve, not so cautiously) either increasing their cash rates or making a big song and dance about doing so in the future. That revised hiking stance is already starting to shift - central bank expectations are being pared back left, right, and centre. Again, the Fed is leading the charge, but the sentiment swing extends beyond the shores of just the red, white and blue. Expectations for our very own RBNZ have undertaken a fairly sharp about face since Christmas. Just before the jolly fat man was making his deliveries,  the market was pricing in a small (~16%) chance of an Official Cash Rate (OCR) hike of 0.25% by November 2019. Today, pricing indicates reasonable odds (~40%) of a 0.25% cut to the OCR by November 2019. Why does this matter? Interest rates and risk assets (like equities) tend to be negatively correlated. They’re dance partners and interest rates do the leading.

Hatch: 2018 saw the end of the longest bull market ever. Do you think 2019 will be Bull or Bear? How should investors prepare?

Jarrod: That’s a tough one.  I think the year will end up being a bear market. But prudent investors will start using the correction to invest in cheapened stocks. There are always opportunities but investors should proceed with caution, particularly this year. The market is panicked and the views of analysts and economists like me are diverging. Some are calling for eventual stability, while others are calling for Armageddon. Those in the latter camp generate more headlines. I believe people and funds are generally underinvested in fixed income products. They’re simply not “cool” enough, or don’t offer enough return. Investors should remember that when Armageddon does come, fixed income products become the coolest thing you’ve ever seen. They can make you money when other investments fail (literally).

Mike: Yup, tough question. Again, I’d be looking to take cues for wider market direction from global interest rates. There’s always going to be intra-day and intra-week noise, but rates should provide a reasonable steer over the medium term. As for preparing, the same rules should always apply – determine your appetite for risk and don’t overeat!

Hatch: Do you think there will be another GFC style recession in 2019? What makes you think so or not? And, if you’re leaning to the pessimistic side, how should investors react?

Jarrod: I’m reasonably confident we won’t have a recession this year. My confidence fades, however, next year and beyond.  There’s enough juice in the tank out there to see growth through into next year. The US and China have plenty of fiscal and monetary fire power to throw at any signs of a serious slowdown, but the real possibility of an escalation in trade conflicts, blended with a bad Brexit, coupled with already frayed investor nerves, and compounded by burgeoning debt levels, means nothing can be ruled out. Again, the world today demands caution, but not panic.

Mike: For me, GFC v2.0 seems unlikely. “Maybe” something else will come along, but 2019 looks like it will dodge that “maybe” bullet. Some have argued that we are “due”, but the world is a very different, and more regulated, place than it was in 2008… or 1997 (Asian crisis)… or 1987 (Black Monday)… or 1979 (oil crisis)… and on it goes.  Sure, asset prices are, by most measures, elevated, and that’s causing a few alarm bells, but (and it’s a big “but”), we’re coming out of an unprecedented period of low and negative interest rates. That old rule book needs to be heaved out the window and a new one downloaded to the Kindle. Has every one of my answers involved rates? There’s probably something I’m trying to convey – subliminal suggestion, etc. To answer the question (finally): watch interest rates and stick within a risk profile that you are comfortable with.

Hatch: We know you've got the inside financial deets. What trends do you see happening in 2019? Are there any hot-to-trot sectors that you think are worth looking into? 

Jarrod: I’m no equity analyst. I’m an economist with a love of interest rates and interest rates are (hopefully) going nowhere in 2019. There’s a growing risk of RBNZ rate cuts and diminishing risk of rate hikes. Good news for borrowers and bad news for savers. We hope we’re not in a position to need rate cuts this year and we still believe the next move is up – but that’s a story for 2020. In terms of sectors, tourism, education, construction and professional services are all set up for good growth, if they can handle the volume. I’m fascinated by the advances in technology expected over the next 10 years. We should see a wave of automation but it also risks widening inequality rather than improving our standards of living.

Mike: Ah, what he said. I’m not sure about having the inside word, but from a personal perspective, a perspective that includes a two-year-old son, it often feels like our household is single handedly supporting both the childcare and toddler clothing industries. Who knows…if we’d started down the family road a few years earlier, perhaps the fortunes of Pumpkin Patch might have been just a (very) little brighter. So, no hot tips, but certainly of interest will be developments in the Australian housing sector and watching how contributors to the comment sections of local websites compare and contrast Sydney with Auckland. Other than that, it’s the macro drivers that spin my wheels.

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