2019 Investment Outlook

By Alexander Forbes Investments on Jan 24, 2019 in Economic Insights General

2019 investment outlook


2019 Investment Outlook – A fragile mix of local policy promises and global uncertainties

A review of 2018: negative returns all-round
Isaah Mhlanga, Executive Chief Economist

The year 2018 came to an end in a disappointing fashion for markets, after starting on a positive note with a
synchronized economic growth outlook that started in 2017. Trade tensions between the United States (US) and its
major trading partners, Brexit negotiations, Italian and Argentinian debt issues, Turkey’s currency problems and more
importantly, the Federal Reserve’s (Fed) interest rate hiking path, all combined over the course of the year and shifted
the outlook for markets from a low-return environment to a negative returns environment, across a broad range of
asset classes. To paraphrase Ernest Hemingway in responding to how he became bankrupt, the market gave away
earlier gains gradually, then suddenly. Oddly, we had no advanced or emerging economy in deep recession, no major
financial meltdown and no major corporate default, to justify the 2018 market’s performance. We believe that we are
at the end of a long economic cycle, which implies that cheap money will become scarce, volatility will rise and there
is going to be more differentiation in economic and market performance across regions and countries.

Asset class returns for December 2018 were an extension of what transpired in much of 2018. Investors sold
emerging market equities and bonds, and piled into global bonds and US dollar cash. The major concerns that drove
this investor behavior were expectations of slower US growth, which in turn affected global growth, continuing US Fed
rate hikes and reduction in global dollar liquidity, trade tensions, a decline in crude oil prices from US$80/bbl to
US$60/bbl, and geopolitical risks in Europe around the Brexit negotiations and Italy’s debt.

Consequently, in 2018 asset class returns were poor across a broad range of asset classes and geographies. Global
equities, represented by the MSCI All Countries World Index (ACWI), returned -7.0% in December, which brought the
year’s returns to -8.9%. This was driven by a repricing of advanced economies, with US S&P 500 returning -9.0% in
December and -4.4% for the year. Europe and Japan also had negative returns in December and far worse for the
year than the US. United Kingdom (UK) FTSE 100 returned -11.8% for the year, in US dollar terms, due to the Brexit
uncertainties negatively impacting both the UK and the rest of continental Europe. UK equities showed an
improvement, in pound terms, and returned -8.8% in 2018, as a result of the impact of the weaker sterling against the

Emerging markets (EMs), as represented by the MSCI Emerging Markets, returned 2.6% in December, as the sell-off
in the first half of the month was partially reversed, due to easing trade tensions and expectations of fewer rate hikes
by the US Fed than what was expected during much of 2018.

The Citi World Government Bond Index (WGBI) outperformed equities in December, and the year. The Citi World
Government Bond Index (WGBI) and corporate bonds returned 2.4% and 1.2% in December, respectively, which
brought 2018 year returns to -0.8% and -3.6%.

In the commodities markets, oil and copper prices saw the biggest declines of 8% and 4.4% in December,
respectively, which brought the year’s declines to 18% and 17%, respectively. By contrast, silver and gold prices rose
by 9.0% and 4.8% in December, respectively. However, for the year they declined 8.5% and 1.2%, respectively.

South African markets mirrored global markets, and this was made worse by the negative domestic economic news
and political and policy uncertainty. The economy experienced a technical recession during the first and second
quarters. The Medium Term Budget Policy Statement showed a deterioration in fiscal outlook, Eskom’s debt burden
and rolling electricity blackouts increased risks for both the fiscus and economic growth. As if this wasn’t enough,
policy miscommunication around land expropriation without compensation negatively impacted market sentiment and
business confidence.

Headline inflation gradually trended up from the 3.8% low in March, peaking at 5.2%, although it was expected to
have weakened. As a result, the South African Reserve Bank (SARB) hiked rates by 25 basis points in November,
affecting the March cuts, such that interest rates ended the year where they started, at 6.75%.

Ultimately, the unfavorable global backdrop and local issues drove the majority of asset class returns into negative
territory. The JSE All Share Index returned -8.5% for the year, despite a rebound of 4.3% in December. The decline in
equities was broad-based across small, medium and large caps. Industrials (INDI25) returned -17.6%, while financials
returned -8.8%, for the year, even though they returned small positives in the last month. Resources (RESI20) bucked
the trend, with a 15.5% return.

Bonds (ALBI) and cash (STEFI) were the best performers for the year, with 7.7% and 6.6%, respectively. Property
(JSAPY) didn’t recover much from earlier declines, returning -25.3% for the year.


2019 economic outlook

Economy of 2019


2019 Investment Outlook: a fragile mix of policy uncertainties

Key market drivers for 2019

  • Global growth is expected to plateau in 2019, driven by the slowdown in the US and Eurozone, which is
    offset by improvement in emerging markets. The outlook for 2020 is less assured, due to rising risks of a US
    recession. The UK should continue to be weighed down by Brexit uncertainties.
  • The moderation in developed markets (DMs) growth should dampen domestic demand, which implies that
    inflation will remain stable and close to targets, enabling a continuation of the removal of monetary stimulus.
  • In terms of interest rate paths, we believe that the rising risks of a 2020 US recession will push the Fed to be
    more data dependent, and pause interest rate hikes, in the absence of an overshoot in inflation. We expect
    the Fed to hike once or twice, at most, and the European Central Bank (ECB) to hike only once in 4Q2019.
  • The US dollar should peak in 1H2019, before weakening against other major currencies. This implies that
    EM currencies should recover from the significant weaknesses we saw in 2018.
  • A recovery in EM currencies, with moderately rising energy prices, should drive inflation lower in oil importing
    countries, which in turn will keep interest rates stable, boosting domestic demand and economic growth. The
    slowdown in China’s economic growth remains a source of risk for EMs, from a trade point of view.
  • On the basis of our base case views, we believe investors will see better returns in 2019, if they are
    positioned in global equities, particularly EMs and US large- and mid-caps, investment grade corporate debt;
    US short-term fixed income, EMs debt, commodities and alternatives.
  • The global backdrop is supportive for South African (SA) fundamentals, from a potential capital flows and
    currency perspective. However, we believe that the national elections in May will prove to be an inflection
    point for both the macroeconomic outlook and investment outcomes.
  • Although there is a generally positive outlook on political outcomes, we forecast a marginal improvement in
    economic growth, to 1.5% and 2.1% in 2019 and 2020, respectively, from sub-1% in 2018. We attribute the
    slower recovery to a delay in policy reforms and private investment until after elections.
  • Inflation should remain well within the 3%-6% target band, because of the stable rand and low oil prices.
    There are little demand-side inflationary pressures currently, low FX pass-through, due to administered
    prices, especially electricity.
  • From an investment point of view, we believe local equities are poised to recover, following an 8.5% decline
    in 2018 total returns. Bonds should still offer good returns, given the stable inflation and an unchanged
    interest rate outlook, however, there remains a risk of one rate hike by the SARB, which advocates for short
    duration positioning.


Global growth steady with increasing downside risks

Global economic growth for 2019 is expected to continue to plateau at 3.7%, as the growth in DMs is expected to
moderate to 2.1% from 2.4%, due to the waning impact of tax cuts and tightening monetary policy in the US and rising
Brexit uncertainty in Europe. Growth in EMs is expected to accelerate to 5.2% in 2019, from the average of 4.8%
between 2014 and 2018, helped by lower oil prices and fewer interest rate hikes, which will offset the weakness in DMs.

However, systemic country specific variations are driven by the US, Germany, the UK and China. The
outperformance of the US is likely behind us, as the boost from tax cuts diminishes and household income gains will
likely stagnate this year. The reduction in liquidity and tightening monetary policy will also start to constrain economic
growth. In Europe, the UK and Germany will see slower growth, but for different reasons. The UK will be weighed
down by the Brexit uncertainty, while Germany is adjusting lower, given the late stage in its economic cycle, with
above trend growth. 

In emerging markets, China is still adjusting to a change in growth drivers, towards consumption led drivers, which
structurally imply slower economic growth. In addition to this, the trade war with the US should negatively impact
growth, but should be offset by monetary and fiscal stimulus, which the Chinese authorities has embarked on.

The balance of risks to this outlook are tilted to the downside, due to political risks in the US, UK, China and several
other EMs holding elections this year. Political risks necessarily create policy risks, in addition to the ongoing trade
wars, Brexit and Italian debt issues. However, we believe that for markets, the biggest risk remains the US Fed rate
hiking path, which at this point, looks set to deliver one or two hikes, at best, which will not trigger a risk-off trade.


2019 economic estimate


Global inflation to stabilise, due to a fall in energy prices and stable exchange rates

Following a rise in the annual global headline inflation rate, to 3.8% in 2018, from 3.2% during the previous year,
inflation is expected to remain moderate, at 3.2%, over the next two years, due to lower oil prices and strengthening
exchange rates against the US dollar. DMs are expected to change from 2.4% in 2018, to 2.0% in 2019 and 2020,
while EMs will stabilise below their five-year average of 4.4%. US, Eurozone and UK inflation rates are expected to
change from 2.5%, 1.7% and 2.5% in 2018, to 2.0%, 1.5% and 2.1% in 2019, respectively. In EMs, Chinese inflation is
expected to accelerate to 2.3%, from 2.1%, driven by looser monetary policy. Other EMs should see varied inflation
dynamics, which we believe will offset each other and leave the EM average stable, below the five-year average.


Gradual monetary policy tightening a reprieve for emerging markets

With lower and stable inflation dynamics in DMs and EMs, respectively, we expect monetary policy tightening to be
more gradual than what was anticipated last year. The US Fed will likely hike once or twice, at most, in 2019, down
from three times previously. Markets are pricing a 35 basis point increase, to 2.85% by the end of 2Q2020, from the
current 2.5%. The ECB will likely hike once in 4Q2019, with risk of no hike, if growth slows down more than expected.

Bloomberg consensus estimates a 30 basis point increase by the end of 2Q2020, from 0% currently. In EMs, we
expect more stable interest rates, compared with the previous year, with fewer countries hiking policy rates. 


Economic outlook


South African economic outlook: Politics and Policy slow recovery

SA’s economic and markets outlook for this year will be impacted by the National and Provincial elections, which are
scheduled to take place in May, in addition to the global factors discussed above. Independent Press Standards
Organisation’s (IPSO) latest survey of voter intentions shows that the African National Congress (ANC) has 61% support.
If the ANC maintains or gains more support at the polls, it will be market positive, as it will mean that President
Ramaphosa has a clear mandate from the electorate to push through the much needed economic reforms that will boost
economic growth. We believe this is the likely outcome, so we expect local equities to outperform local bonds.
From a policy point of view, pronouncements during election campaigns, as we have already seen with the ruling ANC’s
manifesto, will introduce a layer of concerns, even before the outcome of the elections itself, and policy position of the
government that will be established, is in place. Two aspects that are of concern for markets, are the intention to look
into prescribed minimum assets for pension fund investors and the nationalisation of the SARB.


Will prescribed minimum assets be imposed on pension funds?

Talks on tapping into prescribed minimum assets are not new, and they seem to resurface around national elections
and disappear soon after. Currently, there are no prescribed minimum assets, for developmental purposes, for pension
funds in SA. If prescribed minimum assets were to be made into law, it will distort investment outcomes and prejudice
clients whose pensions are managed by pension funds. However, we do not believe that prescribed minimum assets
will be made into law; but it remain a low probability event.


Will the SARB be nationalised?

As it relates to the nationalisation of the SARB, there are two aspects that need to be separated: ownership, mandate
and independence. At its Monetary Policy Committee (MPC) meeting on 17 January 2019, the SARB Governor spoke
at length, clarifying these two points. Firstly, the ownership of the SARB does not impact its mandate and independence.
To us, this means that even if the state were to nationalise the SARB, this will not change its mandate, which is
constitutionally prescribed as “to achieve and maintain price stability in the interest of balanced and sustainable
economic growth in South Africa”. In any case, there are other central banks that are owned by their government that
are independent in how they achieve their mandated objectives. Secondly, given that the independence and mandate
of the SARB is prescribed in the Constitution, changing that will require changing the Constitution, which will be a far
more difficult task to do without thorough economic justification. We believe that the SARB will not be nationalised, and
its mandate and independence will not be changed.


Economic growth will marginally recover

Given our expectations on the political outcomes, we believe economic growth will recover to about 1.5% in 2019, from
an estimated 0.6% in 2018. The recovery is premised on a rebound in household consumption and fixed investment,
especially in the second half of the year. It is a wait-and-see before elections in May, with little economic reforms and,
as a result, little private sector investment. Even after elections, it will take some time to re-organise government,
pronounce and implement policy. Therefore, a pickup of growth is a story of 2020 and beyond.


No rate hikes in 2019, as inflation is well contained within the 3%-6% SARB target band

We forecast inflation of 5.0% in 2019, from 4.8% in 2018. The decline in oil prices and slightly stronger rand against
the US dollar, has resulted in cuts in petrol prices in December and January. However, market expectations are that oil
prices will increase, and the rand will remain slightly weaker. Electricity prices are likely to increase above 10% per
year, for the next three years, given Eskom’s financial problems. Food price inflation will also likely rise, due to poor
rainfall in major maize production regions. These factors will push inflation risks to the upside for the year. What
remains supportive of a better inflation outlook, is the fact that demand-pull inflation remains minimal.

Given our expectations on inflation and the SARB’s inflation forecast of 4.8%, 5.3% and 4.8% in 2019, 2020 and 2021,
we believe interest rates will stay on hold for the rest of the year, with a risk of one hike at best. The bank’s Quarterly
Projection Model forecasts only one rate hike over the forecast horizon.


Fiscal policy has run out of space

Last year’s Medium Term Budget Policy Statement (MTBPS) clearly highlighted a deteriorating fiscal outlook, with a
debt trajectory, which did not stabilise within the medium-term expenditure framework. The risk of unsustainable fiscal
balances (public debt and deficit) will likely remain, if economic growth does not recover, while the interest paid on
debt and expenditure pressures rise. In addition, state-owned companies that continuously need recapitalisation, are a
big risk to the fiscus, especially Eskom. Calls for the privatisation of the electricity utility have long been there, but it’s
unlikely that it will be done any time soon. A credible scenario will be a part privatisation, separating generation,
distribution and transmission. However, given the current financial problems the utility is in, we do not expect Eskom to
be privatised over the next couple of years, which implies that it will remain a risk to the fiscus.


Asset allocation

Rob Price, Head of Asset Allocation

Return expectations better in 2019, but still low

The weak asset class returns experienced in 2018 are expected to improve in 2019, but remain low, still impacted by
the tighter Fed monetary policy, weaker global growth and declining global liquidity. Given the long-term nature of
pension fund portfolios, we centre our investment outlook on the five-year return outlook, rather than one year. The
long-term return outlook has improved, on account of the equity market correction in 2018, but the outlook doesn’t
match up to historical long-term returns. The low-return theme remains intact. There is still a strong case to use
alternatives, in the form of both private equity and hedge funds, to mitigate against downside risks and potentially
bolster returns.


Rob Price


Developed market equity

Developed market equities fell 10%, in real US dollar terms, in 2018. The correction in price in late 2018 implies that
the five-year real return outlook has improved for DM equities, to approximately 4% to 5% (annualised), in US dollars,
according to our estimates. The real cyclically adjusted price earnings ratio, a measure of valuation, dropped from tenyear

high of 24 in September 2018, to 21 in December 2018, but isn’t far below the long-term average of 23 since
1988. DM equities have the added benefit of the global opportunity set, which is a slight constraint for SA equity.


Emerging market equity

Economic growth and return prospects are stronger in EMs, than DMs and South Africa. However, growth is not the
only factor assisting EM equity prospects. Valuations corrected substantially in late 2018 making them more attractive
than levels seen at the start of 2018. US dollar strengthening risks cannot be ruled out while the Federal Reserve is
still expected to hike interest rates, but the USD is closer to the end of its strengthening cycle than the start. Potential
US dollar weakness over the years ahead should also support EM equity returns because EMs are heavily levered to
the US dollar cycle.


Global bonds

The rise in global interest rates in 2018 implies that the five-year return prospects for global bonds have improved.
Bonds could also become a useful diversifier as the end of the US business cycle nears, however, five-year real return
expectations remain negative, in US dollar terms, as interest rates are low and rising, while inflation is ticking higher,
as a trend. After years of ultra-low interest rates and inflation in the DMs, we cannot discount the risk of a change in
conditions towards higher inflation and interest rates, which would be a negative outcome for global bonds. Global
bonds are still considered an unattractive asset class, over the long-term, as a result.


Global cash

US short-term interest rates have risen to the highest levels since 2009, making the US dollar cash a reasonably
attractive asset class, in the face of shorter-term financial market volatility. This is a dramatic shift from the last ten
years, when interest rates were at the zero lower bound. US interest rates are also noticeably higher than their
developed markets peers, because the Fed has continued with its tightening cycle, while other global central banks
remain very cautious. As such, cash allocations need to account for geographical concentration. Longer-term return
expectations from cash are unlikely to compete with growth assets.

SA equity

After falling 12.6%, in real terms, in 2018, SA equities, represented by the JSE All Share Index (ALSI), are expected to
return approximately 4%, in real, CPI-adjusted terms, over the next five years (annualised). Valuations are certainly
better, but constrained economic activity should keep the return outlook lower than long-term historical averages.
Retained earnings, a measure of corporate SA’s confidence in their investment opportunities, is improving, but
remains inhibited, and exemplifies the conditions faced by SA equities. Unlisted SA equities, accessed through
Alexander Forbes Investments’ Private Markets programme, are expected to provide a premium above listed equity,
as it did in 2018.


SA bonds

Despite ongoing credit rating concerns, due to fiscal deterioration, SA bonds continue to offer reasonably attractive
return prospects, as a result of elevated real yields. The yield on the ten-year government bond was more than 4%
above the CPI inflation rate for most of 2018, which is higher than the long-term average for this spread. We forecast
five-year real return expectations from the All Bond Index (ALBI) of approximately 2% (annualised), which is marginally
lower than historical norms from this asset class.


SA cash

Local cash return expectations benefit from the same dynamic as bonds, with positive real return prospects over the
coming years. Prudent SARB monetary policy is the major contributing factor to positive real interest rate conditions.
Given the degree of volatility in financial markets and the risks attached to equity, cash presents periodic
attractiveness, despite its low long-term real return expectation.

Note: Any projections contained in the information are estimates only. Such projections are subject to market influences and
contingent upon matters outside the control of Alexander Forbes Investments and therefore may not be realised in the future.
Historical returns are no guarantee of future performance.

Alexander Forbes Investments

Alexander Forbes Investments

Alexander Forbes Investments was established in 1997. We are a forward-thinking and trusted global investment provider, with roots in Africa. In pursuit of certainty we set out to understand our retail and institutional clients’ circumstances and risk tolerance to set clear goals. Our adaptive investment approach, called Living*Investing allows us to maximise opportunity and minimise risk at every stage of the investment cycle.

More Posts - Website

Follow Me:

Leave a Reply

Search Our Blog

Follow Us