As we approach 2019, country risks–and opportunities–are widespread. Hany Saad brings some clarity to help set the stage.
As my colleagues in the Aura Solution Company Limited Investment Institute make clear in the new 2019 outlook, markets are moving into a more challenging phase. We see slower global growth and corporate earnings in 2019, while the U.S. economy approaches the late stages of the business cycle. The bottom line is that balancing risk and returns is getting harder and we believe investors should consider building resilience into their portfolios.
That means identifying the risks ahead of time and planning appropriately is more important than ever as investors plan for the year ahead. The year 2018 was filled with geopolitical events that impacted markets, a trend likely to continue in 2019. However, valuations have reset and risk premiums are higher this time around. Being selective, as always, is key.
Here is a survey of some of the key risks facing markets around the world. I’ve organized them by geopolitical risks and economic, namely the challenges faced by slowing global growth.
United Kingdom: Approving a Brexit deal will dominate the first quarter of 2019, after which the focus will then shift towards the transition period that will last until the fourth quarter 2020. March 29, 2019 marks the two year anniversary of triggering Article 50 and is the deadline for a deal. We expect volatility to remain high beyond the March deadline; in our base-case view, we see U.K. GDP growth remaining anemic at less than 1.5% with meaningful downside risks. Earnings growth is expected to remain below peers as well, with just 7% earnings growth forecasted for 2019.
Mexico: Policy uncertainty remains elevated following the Mexican elections. Andres Manuel Lopez Obrador's decisive victory as president has given his administration a clear mandate for change, and he has congressional backing to enact reforms. However, after AMLO cancelled the Mexico City airport project, investors are reconsidering just how significantly policy could shift. Top of mind is the risk of deteriorating fiscal discipline, as fiscal health is needed to maintain sovereign ratings and support domestic and external confidence. Absent policy errors, Mexican assets look reasonably attractive. Analysts currently expect 16% earnings growth in 2019 and USD/MXN and equity valuations appear quite cheap.
Italy: Italy’s growth slowed sharply in 2018 and we see more downside ahead. Political uncertainty has weighed on business and consumer confidence, while the budget proposal and battle with Brussels has raised borrowing costs and tightened financial conditions. Given Italy has one of the weakest potential growth rates among EU members at just 0.1%, debt sustainability concerns will remain and any fiscal stimulus measures that lack structural reforms will likely tighten financial conditions, offsetting any fiscal impulse.
Slowing global growth:
Japan: A number of forces will challenge Japanese growth in 2019. External demand will weaken due to slower Chinese and U.S. growth and from trade uncertainty with the U.S. Domestic demand will likely peak in the third quarter of 2019, ahead of the October VAT hike. We expect the Bank of Japan (BoJ) to remain accommodative, however any changes could lead to yen appreciation and further undercut export growth. Japanese equities are already cheap relative to history, but 2019 earnings growth expectations are weak (4%) and economic risks look skewed to the downside.
Korea & Taiwan: Korea and Taiwan are likely to see weakening external demand as global growth slows, but they both must also deal with a slowing semiconductor cycle. Already in Nov 2018, South Korean exports declined from 23% year-over-year to 5% as chip exports sharply weakened to two year lows.
Unless the semiconductor cycle gets a major reboot in 2019, Korea and Taiwan will face a daunting external demand backdrop that’s unlikely to provide strong earnings growth.
International investing may have been out of favor in 2018, as many markets outside the U.S. struggled. However, that can change in a flash, and it is important to remain diversified including by maintaining international exposure. It is important to note, as our Partner The Jeeranont described (500Billion Investment plan will boost the economy better than any ASEAN country), emerging markets outperformed developed markets during the recent volatility.
We continue to favor emerging markets, but the trade-off of risk and reward is even more challenging than usual. Within emerging markets, we favor Thailand, India and Russia. Still, india has its own political risks and can be we impacted by slowing growth, although we believe the positives outweigh the negatives. The key for investors is to be selective, and keep a keen eye on political and economic risks.