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Analysis: Improbable but possible outcomes for 2019

Lightning_strikesValue outperforming other equity factors is one scenario with an at least 30% chance this year, writes Paul Jackson, head of EMEA ETFs research at Invesco.

Central scenario predictions are common this time of year. But it is also worth thinking about improbable but possible outcomes.

After all, the biggest returns tend to be earned – and the biggest losses avoided – by successfully taking out-of-consensus positions.

Below we have sought to outline those unlikely possibilities, the out-of-consensus ideas for 2019 that we believe have at least a 30% chance of occurring.

Capital goods sector outperforms the S&P 500
Recent equity market trends could convince one that the world is in recession. The US capital goods sector has sharply underperformed the wider S&P 500 since February 2018. However, capital goods orders remain elevated, having increased sharply during the first half of 2018. Such divergence between orders and stock market performance appears to often be resolved by a rebound in capital goods sector market performance. We suspect this will happen during 2019 as it becomes clear there is no collapse in US investment spending, nor any US recession.

Theresa May’s plan is accepted; she remains PM
The common belief is that the UK Parliament will reject Theresa May’s agreement with the European Union, with a 2019 referendum thought more likely than a no-deal Brexit. There is also a belief that a general election is more likely in 2019 than any other year between now and 2022 and that Jeremy Corbyn will be the next prime minister. That sounds dramatic and, if it happens, could bring a lot of volatility to UK assets including sterling. However, we suspect that fear of the alternatives will eventually cause Parliament to accept Theresa May’s EU plan (after first rejecting it) and that she will still be PM at the end of 2019.

Fed hikes interest rates twice during 2019
As recently as two months ago, it seemed uncontroversial to say that the Fed would hike twice during 2019. However, recent stock market turbulence has caused a change of mind within the bond market. We think little has changed in the last two months and stick with our two-rate hike view. We suspect the 10-year yield will finish the year above 3.25%.

Value outperforms other equity factors
During the fourth quarter of 2018, the best performing equity factor in both the US and Europe was low volatility. The value factor suffered, especially in the US. However, if broad equity indices rebound during 2019, as we suspect they will, then it is possible that the value factor will outperform other factors because value tends to perform strongly in the early stages of a market rebound.

Italian bonds outperform rest of Eurozone
Italy’s populist coalition government’s budget plan has contributed to a widening of bond yield spreads versus other eurozone countries. The EU threatened punitive action but it now appears a settlement has been reached, presumably involving a smaller deficit. On this basis, we suspect the spread on Italian bonds versus those of Germany will continue the narrowing started in November, implying that Italian bonds will outperform those of other major eurozone countries.

China runs a current account deficit
Chinese current account surpluses have been a permanent feature of the global economic and financial systems. However, the surplus has been shrinking over recent years, with a quarterly deficit recorded during the first quarter of 2018. Were this trend to continue, China could be running current account deficits on a more regular basis. This increases the urgency of Chinese bonds achieving full representation in global bond indices and will likely make the Chinese authorities ever more determined to achieve reserve currency status for the yuan. One effect of Chinese current account deficits could be an easing of trade tensions with the US.

Russian stocks outperform major indices again
The Russian stock market was an outperformer in 2018, finishing ninth out of 68 in our 2018 equity market league table. The Russian Depository Index was on a PE of 5.0 and a dividend yield of 6.2, as of January 2. Even better, Bloomberg consensus forecasts suggest that gap will grow over the coming years, as earnings and dividends are expected to grow. Russian indices do have two drawbacks: first, many investors refuse to invest in the country and second is the exposure to energy prices.

US Vice President Mike Pence gets promoted
We are sticking with this idea from last year, with even more confidence given that the House of Representatives is now under Democrat control. Though we think markets would be largely unperturbed (relieved), we believe commodities would suffer.

Given the current gloomy sentiment, our ‘surprises’ are largely on the positive side. Let’s hope our optimism proves justified.

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