by Diane Freeman
US equity markets finished 2018 having delivered their worst annual declines since the 2008 financial crisis. The S&P 500 fell 6.2% for the year, the Dow was down 5.6% and the NASDAQ was off 3.9%.
Volatility returned and investors, driven by uncertainty, remain pessimistic. As noted yesterday, many will remember the past year as a time when the Trump Bump morphed into the Trump Slump.
Early in 2018 the cryptocurrency bubble burst with a resounding crash. The resulting bear market hung on to close out the year. Investors continue to wonder if and when the asset class will recover.
Crude oil had a tough year too, losing 25% of its value since October, which turned out to be an extremely volatile fourth quarter for the commodity. It was the biggest price collapse for crude since 2014. Surging supply and the fear of shrinking demand frightened investors.
To begin 2019, we asked a few of our most popular contributors where they see markets heading as the new year kicks off.
Matthew Weller: Mirror Image of Early 2018
The pendulum of market sentiment swings ever back and forth between fear and greed, euphoria and despondency.
When I contributed to this report last year, longer-term positioning data showed that traders were extremely bearish on the US dollar's prospects following a disappointing year for the world’s reserve currency, making it a smart contrarian bet to look for strength in the greenback. As of writing (in mid-December), the buck has risen against every one of its major rivals (though it’s essentially flat against the yen), and traders are once again betting on continued dollar strength. According to the CFTC’s Commitment of Traders (COT) report, speculative futures traders are long the US dollar index to the tune of 41k contracts, the highest level since May 2017 and approaching the most bullish level since 2015.
Fundamentally speaking, the US economy may be the proverbial “best house in a bad global neighborhood,” but with the US yield curve flattening, fiscal stimulus from last year’s tax cut fading, and “trade war” tariffs starting to take a bite out of economic activity, the Fed will likely have to tap the brakes on further interest rate increases in 2019. Conversely, the market’s expectations for any progress from other G7 economies and central banks are extraordinarily low. While those subdued outlooks may indeed come to pass, the odds favor a better-than-expected year for some of the dollar’s major rivals, especially the euro and the yen, where traders have amassed their most bearish positions in over a year.
To update the conclusion from my 2018 outlook: We're presented with the mirror image scenario from the start of last year. In other words, the pendulum of market sentiment has shifted from extreme bearishness with low expectations to extreme bullishness with high expectations, setting the dollar up for a far worse year in 2019 than 2018.
Chris Weston: Global Growth, Liquidity, USD Path Are 2019's Holy Trinity
Get the USD call right, and you’ll go a long way to getting one’s asset allocation on the money. It feels as though 2019 could be the year when the USD's lofty valuation could matter, and we see modest mean reversion against a ‘cheap’ (on a PPP or REEF basis) JPY, EUR, and this should compel investors into EM assets in greater quantity. The Fed will likely raise the fund's rate once more, potentially not at all, and importantly we should see a more robust conversation that the Fed’s unwind/normalisation (QT) of the balance sheet could come to an end far earlier than expected. Now, I am not saying we’ll get another round of QE—that seems highly unlikely as Jerome Powell is genuinely worried about the distortions years of cheap money have created.
However, the prospect that the demand for reserves outpaces reserves held in the banking system puts unnecessary pressure on funding costs, at a time when the US and the global economy have increasing vulnerabilities, which would be too great a risk. An early termination to QT would be a game changer for risk assets, and we would advocate high growth, high P/E US tech names and small caps in this scenario.
Before we get to that juncture, and the discussion of an end to QT becomes mainstream, we see risks of further yield curve flattening in the US Treasury market, and inversion in 2s,10s and 3ms. It won't be long before we flip this trade to bull steepeners, which is generally when we have seen a recessions kick in in prior case studies.
The rate cut implied in the Eurodollar futures curve through 2020 suggests the rates market is already signalling that perhaps, after inversion, the front-end will find good buyers and come down aggressively. This feeds into my weaker USD call, as we should see the yield advantage demanded to hold USTs, over say German bunds and JGBs converge, in turn, forcing a liquidation from the USD carry trade.
A world where a weaker USD could play out should see gold do well, especially if ‘real’ (or inflation-adjusted) yields head lower. It's at this point that gold shorts should run for the hills, and we can see the 2018 highs of $1366 challenged.
2018 was a far better year for those who like volatility, although most of the vol was seen in credit and equity markets and FX vols have been quite contained. This changes in 2019 and we should see better vols in FX, but this requires central bank divergence to kick in again, and there is no guarantee this plays out.
We may see a unilateral dovish shift from G10 FX central banks—well, aside from those such as the BOJ who are already throwing the kitchen sink at creating inflation. That said, I think we will see the tides shifting and the paths of the key global central banks moving apart, and this will create changes in yield differentials, and with it volatility and even powerful trends. Short USD/JPY and USD/CNH hold good risk to reward and should they head lower impact other markets such as the Nikkei 225 intently too.
Global growth, liquidity and the path for the USD seem to be the holy trinity for 2019. Get these considerations right, and you’ll be smiling in 2019.
Lance Roberts: End of Decade-Long Economic Cycle
The biggest theme moving into 2019 is the end of the decade-long economic growth cycle. Currently, the market has not priced in either weaker economic or profit growth scenarios.
Although, the movement in the last quarter of 2018 was in that direction, the decline has been small relative to what is occurring in terms of shifts to economic conditions. 2019 will be a year of weaker economic growth, corporate profitability, and a Federal Reserve working to successfully rotate from a “tightening cycle” to an “easing cycle” without causing a financial issue. Given that the Fed rate is roughly half of what it was heading into the financial crisis, and the balance sheet is still 200% higher, the main problem for the Fed will be the lack of ammunition to ease.
More and more evidence continues to mount that a bear market has begun. While there will be some extremely strong reflexive rallies along the way, which the media presume is a resumption of the bull market, we suggest using such rallies as opportunities to reduce risk and raise cash until such time as market trends have resumed a positive, healthy, trend.
Currently, that is not the case.