(26 JANUARY 2019)WEEKLY MARKET OUTLOOK 1:China Slowdown and US Shutdown

Global monetary policy, which was expected to tighten significantly, has shifted in the last month. Markets still expect 2019 to bring tighter financial conditions, but not at the current slower pace. In the US, the Fed is likely to focus on managing balance sheet reduction rather than increasing interest rates. And the dysfunctional and divided government in Washington suggests that expectations of additional fiscal stimulus is unlikely. The announcement of 6.6% GDP growth in China was a wake-up call for the government and the PboC (People's Bank of China). Its measures, however, should help the economy to stabilize and we can expect a steady stream of monetary and fiscal stimulus measures to turn it around. One view is that slower growth and tight monetary policy, combined with a meaningful drop in central bank asset purchases, would lead to a broad risk off sentiment and re-adjustment in global markets. In this scenario, risk premia would rise as investors confident of a central bank risk backstop would see valuations move away from QE-driven appreciations and further outflows from risky assets, increasing the likelihood of a bear market in 2019. Yet the outlook for global profit has clearly deteriorated. Earning growth is expected to decline sharply from above 15% to slightly over 6% on a year-on-year basis. We don't see the S&P 500 rising above 2018 highs, while incoming corporate earnings suggest that near-term positive, outlooks downside risk remains. With US trade deficits growing, pressure will remain on President Trump to pressure US-China trade relations. This will act as a drag on global growth and further drive up risk premia in global equity markets, specifically in technology, which suggests that the rally in chip-makers will be short lived. Despite fears of a global slowdown, commodities have upside potential. Industrial metals, including copper, should get a boost if the PboC achieves its goal of spurring growth. As gold finds safe-haven buyers, massive US twin deficits and China flooding markets with stimulus liquidity, the faults in the global capital system have been highlighted once again.

By Peter Rosenstreich