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Global economy

Global markets: Three themes to watch

in 2019

As we look out to 2019, we believe there Geopolitical disruption. We have seen

are three key themes that will persist into significant geopolitical disruptions in recent
the new year. months, which threaten structural
fragmentation in the global economy and are
1. Divergence already contributing to divergence in global
While we expect economic growth to remain growth as well as creating significant volatility
solid, there has been greater divergence in in financial markets. For example, the
the past year in terms of growth. We believe rejection of Angela Merkel’s leadership
such growth divergence is likely to continue, in various German regions, the difficulty
yet it will probably be constrained by the the UK has had in orchestrating its Brexit
Kristina Hooper strength of US consumption and investment from the European Union (EU) and Italy’s
Chief Global (as well as the strength of Chinese stimulus), tensions with the EU over its desire to
Market Strategist which is likely to help boost growth in the rest increase government spending in violation
New York of the world to at least some degree. We also of Eurozone rules are contributing to volatility
expect some divergence in inflation in the and pressure in European markets including
coming year, with some economies the euro, government bonds and equities –
experiencing upward pressure on wages as especially bank stocks, and are likely to drag
well as rising input costs. down growth in the UK, Italy and to some
extent Europe as a whole. The US withdrawal
2. Disruption from the Iran nuclear accord had contributed
Monetary policy disruption. The US Federal to a surge in oil prices because the hard line
Reserve (Fed) is very likely to continue on its requiring sanctions compliance by many
path of regular gradual rate hikes. It would countries pointed to much tighter global oil
probably take a major downturn in economic supply, but the granting of many sanctions
data or a very severe US stock market waivers has now lowered this risk
correction to divert the Fed from that rate contributing to a sharp oil price correction –
Arnab Das hike path at this juncture. In addition, the Fed all of which has affected currencies and
Global Market Strategist, is also conducting balance sheet markets in many oil exporting and importing
EMEA normalization – a powerful tool in and of itself countries. Of course, the greatest geopolitical
London at the same time as it is raising rates. The risk is the potential for fullvblown trade wars,
preset course calls for larger amounts of which seems more likely than not at this
assets to be rolled off the Fed’s balance sheet juncture. This can place downward pressure
each quarter. which means a significant on economic growth in a variety of ways:
possibility of market disruption (we have It increases economic policy uncertainty,
already seen US monetary policy disrupt which typically reduces business investment;
emerging markets in 2018). In addition, the it increases input costs, which reduces profit
Key takeaways European Central Bank (ECB) is due to begin margins or is passed onto consumers, who
• We believe economic winding down its own quantitative easing in turn typically reduce their spending in
growth divergence is program from the end of 2018, which could other areas; or it results in demand
likely to continue to contribute to further disruption in Eurozone destruction. Finally, it can disrupt supply
some extent. bond markets, which are already chains and make economies less efficient
• Geopolitical disruption experiencing renewed divergence. Plus there and productive. There is hope for renewed
is leading to structural is the risk that, in October 2019, a more negotiations, perhaps starting with a truce
fragmentation. hawkish president could replace Mario Draghi at the lateNovember G20 Summit, when
• The debt problem as ECB President, which may in turn cause Chinese President Xi and US President Trump
is widespread and greater volatility for Eurozone stocks and are expected to meet. But we would caution
is becoming more bonds. In addition, more emerging markets that any relief rally could be temporary,
burdensome as rates rise. economies are tightening many doing so to because US concerns span many areas
keep up with the Fed – creating an overall beyond trade, including intellectual property
environment that is less accommodative. protection and national security.
3. Debt overhang volatility and perhaps even reduced corporate
The world is becoming increasingly indebted. earnings power if US firms have less access
In a recent Global Financial Stability Report, to global markets, including China – which
the International Monetary Fund warned has until now been expected to continue as a
about the growing debt overhang occurring major driver of global growth and a major
in different economies. This problem is source of revenue and earnings growth for
widespread impacting households, companies both US and other multinational firms.
and countries and it becomes more
burdensome as rates rise. For example, Even with these downside risks and volatility,
Canadian homeowners are showing signs of we would expect US bonds to perform
coming under pressure given that many have relatively worse and US stocks to post
adjustablerate mortgages. And the modest gains because of their greater
headwinds that many emerging market exposure to the US economy and structurally
economies have faced in 2018 can be at greater insulation from frictions in trade and
least partly attributed to higher borrowing geopolitics. In the Eurozone and Japan, we
costs. As monetary policy normalization expect continued support of risk assets
continues and accelerates in coming years, because of more accommodative monetary
this pressure is likely to increase. In addition policy, which in our view should result in
to the shortterm effects of debt pressure, modest positive stock returns for those
there is a longterm effect as well: More regions despite relatively low economic
money spent on servicing debt means less growth. In emerging markets (EM), we expect
money that can be used for consumption the Feddriven repricing to continue to spill
or for more productive purposes such as over into global markets through a stronger
investment. That combination can negatively dollar, higher US bond yields and tighter
impact both growth in the current business global financial conditions, pointing to more
cycle, as well as the growth potential of pressure on EM currencies, putting downward
economies with high debt in the longer term. pressure on growth and upward pressure on
inflation – a challenging scenario for EM
equities, bonds and currencies. However,
More money spent on servicing debt there is a significant possibility that by
means less money that can be used for midyear 2019, the Fed may moderate its
consumption or for more productive normalization as economic growth slows,
purposes such as investment. which should result in some moderation in
the investment implications mentioned
above, in our view.

Implications for markets We expect unusual behavior to continue

As monetary policy normalizes, we believe across commodities with the trend toward a
capital markets will normalize as well. That strong dollar, divergence between the US and
means an erosion of the support that Fed the rest of the globe, and the risk of global
policy has given to US stocks. In this growth downgrades pulling the overall
environment, we expect continued volatility commodity complex down. Base metals are
and a continued reduction in correlations among the commodities more exposed to
both across national financial markets, as these downside risks, driven by the
well as among stocks within countries as deleveragingled slowdown in China and the
fundamentals become more important. In general downward pressures on global capex
addition, normalization of US monetary due to trade frictions. Against that, however,
policy suggests that US asset markets are geopolitical risks and trade tensions hold out
prone to mean revert over the course of this the prospect of continued divergences across
unusual cycle, with downside risks stemming commodities, notably in oil, where tensions in
from trade tensions and geopolitics. Mean the Middle East may cause renewed upward
reversion could result in somewhat higher prices pressures. Soft commodities remain
bond yields and discount rates for corporate exposed to developments in US China
cash flow. And, it would probably be reflected negotiations, with China’s tariffs on US
in higher corporate credit and equity risk agricultural exports representing a potential
premia, while the potential for even partial bargaining chip in any negotiations that
fragmentation caused by geopolitical might lead to a reprieve or succumb to a new
disruption would likely result in higher round of tensions or tariff increases.
In this environment, we believe exposure to We believe that exposure to
risk assets is important for meeting longterm alternative investments can help with
goals – especially given that we see a diversification and risk mitigation.
continued upward bias for stocks, although it
is growing weaker. Mitigating against
downside risk will be critical, and that
includes being welldiversified within equities
and fixed income, in our view. This is also
important given the divergence in growth in
different economies. And, perhaps most
important during this period of uncertainty,
we believe that exposure to alternative
investments can help with diversification and
risk mitigation. That may include strategies
such as market neutral portfolios and other
lower correlating asset classes, especially
ones with incomeproducing potential.

The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from
those of other Invesco investment professionals. There is no guarantee the outlooks mentioned will come to pass.
Past performance is not a guarantee of future returns. Diversification does not guarantee a profit or eliminate the risk of loss.
Correlation indicates the degree to which two investments have historically moved in the same direction and magnitude.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices
generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease
in value and lowering the issuer’s credit rating.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic
instability, and foreign taxation issues.
Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather,
political, tax, and other regulatory and market developments.
Stock and other equity securities’ values fluctuate in response to activities specific to the company as well as general market, economic and political conditions.
Alternative products typically hold more non-traditional investments and employ more complex trading strategies, including hedging and leveraging through
derivatives, short selling and opportunistic strategies that change with market conditions. Investors considering alternatives should be aware of their unique
characteristics and additional risks from the strategies they use. Like all investments, performance will fluctuate.
This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making
any investment decisions.
Invesco Advisers, Inc. is an investment adviser; it provides investment advisory services to individual and institutional clients and does not sell securities. Invesco
Distributors, Inc. is the US distributor for Invesco Ltd. Each entity is an indirect, wholly owned subsidiary of Invesco Ltd. IVZCIOKHM-COM-1-E 12/18 US13592