Our Expert Financial Insights

Brace yourselves for 2019
Thursday, 7th February 2019

The last quarter of 2018 saw major moves that defined our own portfolio returns: stock markets taking a wild ride, gold making a resurgence after crashing out in 2Q, energy prices continue to surprise the market to the downside and Brexit woes dogging the Sterling Pound.

2019 will see these issues being resolved or at least played out for the world to see but investors should be aware of the contexts that underlie the markets.

Keep your eye on interest rates – but not necessarily up so soon.

Professional investors are watching Fed Rate movements like a hawk for good reason: Any drastic change to the US inflation rate (currently 1.9%[1]) will spell more volatility in the US markets given its direct impact on asset prices and cost structure of doing business.

The US earnings season since November have investors jittery about earnings surprises, higher rates, increased raw material costs, lowered foreign currencies, tariffs and demand from China viz trade war will impact stocks.

The thing for investors to note is the rate of change of Fed rate movements. For a while in 2018, the Fed looked headed for hawkish overtones and aggressive (and progressive) rate hikes, but given the softness of the stock market in this light, the Fed seems to have ratcheted back somewhat. This has started to invert the yield curve, with longer-dated US treasuries being less popular amongst investors. In most cases, this is bellwether of a bear market.

In addition, there is an old elephant in the room….

…and this is the immense $12 Trillion liquidity[2] the Federal Reserve and the major central banks have injected over the last 12 years. If you call “quantitative easing” by another name, you have “printing easy money”.

In addition to this, The Fed and the European and Japanese central banks have cut interest rates to a nominal 0% (some have gone below 0% even).

These policies have led to easy money flooding the stock markets for the last 12 years, and is directly responsible for equity price increases in stock markets globally.

Why is this important to note? One chart is enough: S&P 500 versus the US Federal Reserve Bank balance sheet.

Source: FRED, Federal Reserve Bank of St. Louis[3]

The above chart simply shows that whenever the Fed does its Quantitative Easing, it aggressively buys US Treasuries (bonds). During these phases, net assets of central banks go up, and this liquidity finds its way into the stock market.

The corollary is that when these bonds mature, the reverse could just hold true…with bulls exiting at the same time.

Don’t take it from us. Perhaps take heed from the current Fed Chairman who said this long before he was Fed Chairman:

“Right now, we are buying the market, effectively, and private capital will begin to leave that activity and find something else to do. So when it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response.

When you turn and say to the market, “I’ve got $1.2 trillion[4] of these things,” it’s the sight of the whole thing coming. -Jerome Powell (October 2012 Federal Open Market Committee Meeting)

Enough said. Batten down the hatches for 2019.

Kevin Ho
Chief Investment Officer
Capital Asia Investments

The views expressed are the views of Capital Asia Investments only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable as of the date of presentation, but their accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

[1] For the 12 months ended December 2018, as published on January 11, 2019 by the U.S. Department of Labor
[2] Increase in total assets of the Fed, ECB & BOJ from 2007 to 2018, as per Yardeni Research
[3] Board of Governors of the Federal Reserve System (US), All Federal Reserve Banks: Total Assets [WALCL], S&P Dow Jones Indices LLC, S&P 500 [SP500], retrieved from FRED, Federal Reserve Bank of St. Louis;, February 7, 2019.
[4] In reference to the $1.2 trillion (in 2012) of Mortgage-Backed Securities that the Fed wishes to offload from its balance sheet, which has now ballooned to $1.73 trillion.