Mid-year Market Review 2019

1. Mid-year Market Review & Outlook 2019*
aving already passed the halfway mark in 2019, this is perhaps an apt time to
take stock of some of the key trends in the global markets and what this means
for the rest of year. Market behaviour and psychology was to a large extent
dictated by central bank action as well as the unfolding US-China trade war. While
these macro developments are not new, they still haven’t run their course and in our
minds are likely to continue to play an outsized role in shaping market dynamics going
forward.
Against this backdrop, we will initiate this note with a “top-down” view of the global
economy and then move on to look at the performance of the major asset classes over
the first half of this year. The final part of the report will provide a guide in terms of
some of the potential themes to watch as we move through the remainder of this year.
1. H1 2019 marked a worsening of the global macro backdrop…
Global markets have had a lot to contend with during the first half of 2019. Of particular
note has been the slowdown in world growth. Indeed, global growth momentum
continued to slow through the first half of this year, while at the same time most of the
major economies have progressed towards more advanced stages of the business
cycle. Additionally, the synchronized deceleration in global industrial production
continued unabated, with the share of major countries with expanding manufacturing
orders dropping below 50% for the first time since 2015 (see Chart 1). Global trade
growth, meanwhile, also moved into recession territory, weighed down by both the
manufacturing slowdown and trade policy friction, particularly between the US and
China.
* Note prepared in a freelance capacity by Amír Khan (Contact email: amir.khan.uk0709@gmail.com)
H

2. 2
Against this backdrop, our sense is that global economic momentum has peaked and
could yet take a leg lower. That said, we think that recent talk of an outright recession
is wide of the mark. For one thing, policymakers across both developed and emerging
economies have signaled an easing bias and this could serve to backstop global
growth for the time being at least. Separately, the current slowdown of the global
economy is largely confined to the manufacturing sector, while the services sector of
the economy, particularly in the US, has held up much better. This is, in part, thanks
to the fact that the labour markets in countries, such as the US, have continued to be
resilient which has helped to cushion consumer spending – a mainstay of such
economies. Going forward, a key concern is the extent to which the industrial
slowdown and rising tide of protectionism at the the global level could spill over on to
the services/consumer side of the economy – a development which would certainly
make the policy response on the part of the authorities that much more difficult.
2…But markets continued to eke out positive returns
Investors began 2019 cheering the global rally in risk assets that followed a dramatic
late-2018 market plunge. The tough fourth quarter caused the Fed to stop raising rates
despite a strong US economy, aligning the Fed more closely with other major central
banks that are keeping rates low. However, as 2019 progressed the markets turned
more volatile in the face of a more fragmented economic environment with multiple
pain points:
 Investors – who are known to cherish certainty and policy predictability – found
themselves caught up in the disruptive fire of the US-China trade war, which is
turning into “tech cold war” that threatens to disrupt global supply chains.
 Europe is still vulnerable to Brexit uncertainty and, with established leaders such
as Mario Draghi of the ECB and Germany’s Angela Merkel on the way out, this
may slow critical decisions within the bloc.
 The US has continued on the late-cycle path with growth easing back to around
around 2% and expectations growing of a recession in 2020. Indeed, these fears
have grown with the recent inversion of the yield curve, which has in the past
served as a reliable signal of an impending recession.
Despite these growing headwinds, markets – both equity and fixed income – recorded
positive performance in the first half of this year as outlined in Chart 2 below. Of
particular note here is the fact that developed market equities on the whole
outperformed their emerging markets peers by a fairly comfortable margin over this
period. Meanwhile, within the fixed income space, despite worries over high
valuations, returns were pretty respectable at around 7% on average.

3. 3
The fact that both the equity and fixed income markets (particularly government bonds)
rose in tandem during the first half of this year is rather unusual, but there are two
differing explanations for this phenomenon:
 The equity markets have taken the view that with central banks willing to come to
the rescue of their respective economies, this will help to insulate slowing
economies and thereby boost the prospects of the corporate sector.
 Conversely, the sovereign fixed income markets have interpreted the recent
economic slowdown as being more durable in nature. This, coupled with muted
inflationary pressures, will according to this viewpoint likely keep the monetary
authorities in a prolonged easing bias, thereby increasing the appeal of safe-haven
assets such as US Treasuries.
While the jury is still out in terms of which of these two schools of thoughts will
ultimately prove to be correct, the key point to note is that uncertainty going into the
second half of this year has ratcheted up somewhat and this will in our view provide
the basis for greater market volatility during the remainder of 2019.
3. Key investment themes ahead
Notwithstanding the broad-based nature of the market rally outlined above – which
has been dubbed the “everything rally” – its sustainability as alluded to above remains
in question. To this end, we are of the view that following themes or considerations
will be of key importance going forward.
i) Fed policy action
An accommodative Fed has been central to the upward trajectory in risk asset during
the first half of this year. As such, all eyes will be on it and other major central banks
in terms of their policy actions and how markets respond to them going forward. Our
sense is that the Fed – which cut rates at its July meeting – will do so again at least

4. 4
once more this year in order to keep the markets on-side and to avoid unwanted
tightening in financial conditions.
Key takeaways:
 Interest rates now seem likely to remain “lower for longer”. With markets already
pricing several rate cuts, investors expect continued low returns for traditional
bonds, though they are likely to prove to be an attractive option if recession risks
continue to rise.
 Contrary to expectations, the US dollar continued to rise during the first half of this
year despite the Fed signaling an easing bias. While a further strengthening of the
US dollar cannot be ruled out, we believe that it may peak in value during the
remainder of this year. Such a scenario would offer further relief to emerging
market assets in particular.
ii) US/China trade war
Amid the heightened trade tensions between the US and China, Trump has not just
resorted to the imposition of tariffs on Chinese goods, but has also singled out leading
Chinese companies, such as Hauwei, for engaging in “intellectual property theft” and
other such unfair trading practices. Such action, could run the risk of upending global
supply chains if countries are forced to choose between Chinese and American tech
ecosystems while the two countries vie for leadership in big data and artificial
intelligence.
Key takeaways:
 The “tech cold war” could undo the globalized low-cost, high margin supply chains
of many US and Asian tech companies.
 With large American tech firms already under fire for privacy issues, new US-China
tensions could cause their valuations and expected returns to decline.
 Cyber security and defense stocks may benefit from rising geopolitical hostilities.
iii) Earnings concerns
With concerns over the health of the global economy at the front and centre of
investors minds, the question doing the rounds is to what extent this will impact
corporate profitability. Here the point to note is that the earnings growth of S&P 500
companies declined by some 0.2% in Q1 of this year according to data from FactSet.
If a negative reading is confirmed for Q2 as well, it could mark the onset of an “earnings
recession” that could drag on for a while longer given the increasingly parlous state of
the global economy and the strength of the US dollar, both which could stand to impact
large companies in particular thanks to their international orientation.

5. 5
Key takeaway:
 In light of the anticipated slowdown in corporate profitability, investors may be more
minded to shun so-called “cyclical sectors”, such as industrials and materials that
are deemed to be sensitive to the economic cycle, in favour of those that are more
“defensive” in nature e.g. the pharmaceutical and utilities sectors.
iv) Gold & other safe haven assets likely to be in the ascendency
With global central banks, in the quest to cut rates, embarking on a “race to the bottom”
and geopolitical tensions on the rise, risk aversion has been the order of the day so
far this year. As such, gold and other safe haven asset have been bid-up and this is
set to continue in the second half in our minds.
Key takeaways:
 Gold’s rise will not just be underpinned by investors demand for the yellow metal
as global uncertainty rises, but will also be supported by global central bank
purchases of the commodity. Indeed, this already appears to be happening with
the likes of the Chinese and Russia central banks stepping up their purchases of
the metal in order to diversify their foreign exchange reserves away from the US
dollar.
 As investors continue to pile into so-called safe haven assets, such as US
treasuries, this will further depress global bond yields and will add to the value of
negative yielding global bonds which have already topped the US$15bn mark
(~30% of the global bond market).
4. Taking stock/concluding thoughts
Global markets notched up a pretty impressive performance in the first half of this
year, led by the equity markets. Notwithstanding the slowdown of the global economy
and the intensifying US/China trade war, we expected this positive performance to
continue in the second half as central banks step up to the plate with further stimulus.
That said, in an environment of macro uncertainty and ongoing trade tensions, we
think that safe haven assets, such as government bonds and gold, will outperform
equities in the second half of this year.
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