Nowhere near a recession

• While we have clearly passed the peak in global growth, we believe that we are nowhere near a recession
• Risk appetite has recovered since the start of 2019, but remains fragile in light of ongoing political and geopolitical uncertainties
• We continue to look for diversifying and de-correlating strategies, such as alternatives, in a complex environment

Macroeconomic overview

• Fears over a global slowdown have eased in light of ongoing US-China trade talks and a more dovish Fed, and we remain of the view that fundamentals are ok. Yes, growth has peaked and we are going to see slower growth in 2019 than in 2018, but we do not think we are anywhere near a recession. Chinese growth is decelerating, but we expect policymakers to manage the slowdown with targeted stimulus. US data has been stabilising, with the ISM rebounding last month and the labour market still tight. 
• It looks like President Trump will reluctantly sign an agreement that doesn’t include full funding for his border wall but will avert a second partial government shutdown. With this seemingly resolved, markets will likely turn their attention to the debt ceiling discussions, as a credit rating downgrade remains a possibility, and markets are unlikely to be immune.
• European political headlines continue, as the French ‘gilets jaunes’ movement persists, and Italy’s sharp slowdown in growth is throwing a spanner in its 2019 budget targets. In addition, the Brexit saga continues, as both sides appear to be running down the clock. For now, the UK economy is in wait & see mode, with growth suffering as a result.
• The Fed pause has been confirmed and markets don’t expect any Fed hikes for the whole year, but we do not think the Fed’s pause will be that long, unless data significantly disappoints in the coming months. We believe that if growth stabilises and trade tensions ease, the Fed will hike. For now though, with core inflation at 2.1%, there is not much incentive for hawkishness.  Across the pond, we expect the ECB to stay put throughout 2019, with European growth slowing and no inflationary pressures. We believe that data will stabilize at lower levels throughout 2019, but we could still see some long-term lending measures from the central bank to support the banking sector in the coming months.
• Headlines continue from the US and China on the road to a trade deal. Both sides have cited progress and President Trump has said he is willing to extend the March 1^stdeadline if they are close to a deal, but we probably won’t know until the last minute. Moreover, trade tensions between the US and Europe could get reignited by automobile tariffs on Europe, which would weigh on German growth and on European assets.

Market outlook 

• The rally we have seen in markets since the start of the year continues, supported by dovish central banks, and hope for a trade deal & a positive resolution to Brexit, but growth fears haven’t vanished and sentiment remains fragile. Earnings growth expectations have come down significantly, especially in the US, but this is already reflected in markets and we believe that they will hold up around mid-single digits. As such, while we expect higher volatility, we still do not think it is time to remove all risk from portfolios as we believe risk assets will continue to grind higher in the coming months – though not at the January pace. 
• We continue to believe that US equity markets will outperform over the medium term, as European markets remain mired in a wall of worry between politics (Brexit, Italy, France) and slowing growth (Germany, France, Italy). However, the downside in European assets is more limited and we have seen a bounce in markets despite disappointing news, an encouraging sign that European markets can perform well in the short term. 
• US Treasury yields have stabilised around 2.7% for US 10-year, finding a balance between a recovery in risk appetite and ongoing medium-term growth fears. We do not expect a move higher even if trade tensions abate, as expectations for a Fed on pause and a growth slowdown should act as a ceiling. We continue to look for flexible, absolute return strategies, but also believe that more core strategies as protection are becoming interesting. 
• Credit spreads have continued to tighten since the start of the year, partially retracing some of 2018’s widening. In the coming months, we do not expect a significant credit event as fundamentals remain relatively healthy, but some caution is warranted as spreads remain tight from a long-term perspective, and slower growth could lead to widening.
• Looking further into 2019, the complex investment environment we are navigating is unlikely to abate, implying that absolute return, more flexible strategies that can diversify portfolios continue to be welcome additions. We expect risk assets to continue to grind higher, and maintain our exposure. It might not be time to add too much risk, but we don’t think it’s time to take it all off either.

By Etsy Dwek, Senior Investment Strategist, Natixis Investment Managers