The excess of pessimism at the end of 2018 resulted in a sharp decline in financial markets and renewed volatility. According to our analysis, market participants priced in twice the slowdown risk that economic fundamentals justified.
We think that risk assets have now reset to more attractive levels andsome “entry points” for long-term investors are materialising in emerging market (EM) assets and developed market (DM) credit, both of which suffered brutal valuation resets last year, the former in the first part of 2018 and the latter at the end of the year. European equities could follow in this “entry” sequence, but we believe more robust opportunities will materialise later in the year as the European elections in May (and Brexit) could continue to weigh on investor sentiment.
The nearing end of the Fed’s tightening cycle and the stabilisation of the US dollar would undoubtedly be extremely favourable elements, as would a decline in geopolitical tensions or a scenario of economic slowdown without recession risk. A 2% threshold for US growth and 3% for global growth are key levels to support our view on risk assets.
We are aware that risks have not disappeared: there are many geopolitical hotspots and global debt is skyrocketing. This means that a strong focus on the sustainability of earnings and debt is needed to build resilient portfolios.
In EM, in terms of ranking of return potential for 2019, we see equities as the most appealing, followed by EM bonds in local currencies(LC) and hard currency (HC) debt (with LC debt expected to be more volatile than HC debt).This is a change of view compared with last year, when the pressure on currencies had been too high and we were very cautious on EM debt in local currencies. In terms of the investment approach for this market phase, we think sensitivity to multiple themes (external imbalances, electoral cycles, domestic growth engines and trade disputes) will be the key to driving selection in the EM space.
In DM credit, some value has been restored too, amid more dovish central banks and still decent economic fundamentals. European credit (especially in the primary market) will be the main brick to deliver returns in European fixed income portfolios in 2019.
The focus, both in Europe and even more so in the US, where corporate debt is at a historical high, will be in seeking stories with good corporate fundamentals.
The high leverage in the system and the deterioration in credit standards are both elements to watch closely and they will require investors to be highly
