investment outlook key investment themes

Investment Outlook: Three investment themes to focus on in 2019

Every year, Credit Suisse determines the top investment themes in its Investment Outlook. For 2019, they are interest rate normalization, regional economic divergence, and new geopolitical regimes.

1. Interest rate normalization stokes fear of inflation

The cycle is at an advanced stage, but recession is still not imminent and central banks continue to normalize interest rates. Against this backdrop, investors inevitably wonder how to invest. The investment experts at Credit Suisse favor keeping a growth tilt in portfolios. This means focusing on assets that have consistently outperformed during the later phase of past expansions.

For now, inflation is not likely to break out of its 25-year range, and thus the extent to which bonds can enter a bear market is limited. Given the low level of yields this time around, corporate bonds in particular seem quite an unattractive late cycle investment.

Equities and commodities tend to outperform

Equities, on the other hand, tend to rally strongly in the later stage of the expansion. Within equities, small caps have underperformed large caps and cyclicals have quite consistently outperformed defensives. Commodities as well and especially gold have tended to appreciate consistently.

The exceptional bull market in this cycle is an inherent argument for reducing market risk through diversification in uncorrelated sources of income. Additionally, tightening monetary policy and high valuations mean that forward-looking returns are likely lower than they have been.

real return and projected inflation

How much further can real yields go?

Real yield and inflation expectations (derived from 10-year US Treasury Inflation-Protected Securities, 12-month moving averages, in %)
Source: Bloomberg, Credit Suisse; Last data point: 30 October 2018

2. Regional economic divergence

Differences in the relative strength of labor markets and economic growth between countries had a great impact on monetary policy. Driving growing interest rate differentials and large currency moves resulted from this. This has incentivized capital to flow into the USA, pushing the US dollar higher, but has also exposed weaknesses in emerging markets (EM) with large imbalances, like Argentina and Turkey. This helped drive further capital into US assets, creating a vicious cycle for EM.

There are also a number of divergences in EM. If the capex cycle in developed markets (DM) continues to pick up steam, this contrast should become even larger, as surplus economies would benefit from a large rise in DM imports. It is important to look for large divergences between fundamentals and prices in order to find attractive investment opportunities. This means that it may make sense to own current account deficit countries or to sell current account surplus countries.

Financial market forecasts / performance 2019

Equities* 2018 YTD performance on 07 November 2018 2019 expected total returns
US equities 6.78% 5.50%
EMU equities –4.21% 4.00%
Swiss equities 0.14% 4.80%
UK equities –4.04% 5.00%
Japanese equities –6.31% 1.50%
Emerging markets equities –7.04% 8.30%
10-year Bond yields Close on 07 November 2018 End-2019 forecast
US Treasury yield 3.24% 3.30%
German Bund yield 0.45% 1.00%
Swiss Eidgenossen yield 0.02% 0.50%

* Performance and expected returns are total return including dividends. Markets refer to MSCI country / regional indices in local currency.
Note: Historical and/or projected performance indications and financial market scenarios are not reliable indicators of current or future performance.
Source: Thomson Reuters Datastream, Credit Suisse

3. Globalization of the economy affects geopolitics

The last 40 years have seen increasing globalization and free trade, deregulation and a focus on reducing the role of the state in society. These policies created three decades of strong global growth.

With the positives came unintended consequences: boom and bust cycles; a sharp fall in the bargaining power of labor; and rising inequality. Immigration has given disillusioned voters an easy target for their anger. All of this has led to the rise of populism, which is likely to gather further momentum.

Trade and inflation pose risks

So what are the implications for markets? Beyond trade, the main risk is inflation. Investors have been conditioned to believe that inflation cannot rise meaningfully and thus neither can bond yields. Combined with high debt levels and an unsustainable fiscal trajectory, this creates a key risk.

Were such a risk to materialize, it is likely that the bond-equity-correlation would reverse, which would reduce diversification in portfolios, and real assets would benefit. To be clear, we are not likely close to a real inflation shock, and it would probably need a severe economic slowdown to happen. However, buying cheap inflation protection when it is available makes sense.