For the better part of the last two years, we have been positive about the broader economic outlook, confident that improving global growth and strong corporate earnings would drive markets higher. At the same time, reasonable valuation levels only added to our positive view. And this view turned out to be largely correct, with the key economies of the U.S, China and Europe, experiencing a period of synchronised market and economic improvement.
Meanwhile, the local environment has also held up well. Growth has been solid, if unspectacular, the strength of the labour market has been a surprise, corporate earnings growth has been strong throughout, and we have had the benefit of the end of the property cycle.
As we move into 2019, however, a range of headwinds present distinct challenges - playing out in the geopolitical arena, in the form of trade wars, on the policy front, in the form of divergent monetary policies, as well as a slowing Australian housing market. While rising headwinds present challenges, positive features of the Australian equity market support our cautious optimism in 2019.
Trade and tariffs: What are the consequences?
The trade conflict between the US and China has been escalating - and it may get worse before it gets any better, given neither side is willing to yield first. The U.S. wants to secure a better deal for the U.S. and is becoming increasingly isolationist when it comes to its global trading relationships. This is not just about trade and tariff issues, it's about one super power trying to assert power over another, and how they maintain that dominance moving forward.
A less visible, but potentially greater risk, of the trade conflict is the impact on US inflation - higher prices caused by tariffs could lead to an upside surprise in inflation data, and a subsequent sell-off in US rates and equities. In addition, companies with big supply chains through China, for example, are beginning to see costs rise, leading to margins being squeezed and, ultimately, to corporate earnings coming under pressure. So, as a direct result of trade and tariff frictions, the outlook for corporate earnings is now more uncertain.
Although the potential fallout from a U.S./China trade war on global growth is a source of ongoing concern, the 90-day trade and tariff ceasefire agreed by the respective leaders in early December is being viewed as an important and welcome breakthrough. As part of the truce, the two countries have agreed to temporarily halt increasing tariffs as they work towards a more permanent agreement. However, there is still some way to go in the trade story and this theme is likely to play through 2019.