I say high, you say low

You say why and I say I don't know, oh no

You say goodbye and I say hello – Beatles, 1967 

We end the 2018 Annus Horribilis with a clash of hope and fear, a duality of better growth for the US and worse for China and in that divergence blame for a rising tide of uglier politics, anti-global sentiments, and renewed market volatility. The outlook for 2019 converges upon the global recovery receding with the US/China trade war and its fragile peace fractured by other clashes about US hegemony from Russia, to Turkey, to Europe, to the Americas. The US midterm elections did little to assuage fears of the ongoing rise for President Trump in dismantling the global order as the divide in the US politics finds similarities in the UK and Europe. The chart of a nation divided becomes a metaphor for deconstructing the year and building out a view for 2019. 

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Let’s start with the last week, then the December 2018 month in review and work back to the highlights of 2018 to get a perspective on what may be different in 2019 and whether the same themes from last year dominate the year ahead. The bounce back in US equities from last Monday stands out. The rally isn’t sufficient to make 2019 easy but it took some of the pain away from December. The result for the year is likely to remain horrible and sets the tone for whether the market is flashing a yellow sign to the Fed to ease or at least stop raising rates.  The focus on FOMC policy and its divergence from the rest of the world was part of the year and part of the reason for why this was an annus horribilis. 

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The strength of the present US economy contrasts to the gloom in equity markets.  The start of a bear market (defined as >20% from a peak) was in effect for much of the world and that engulfed the US as well this last week on Monday but the reaction of markets is to future expectations rather than present conditions. The battle of how to balance risks breaks like the see-saw of bonds against equities. The magic of QE and zero-interest rates in inflating assets prices now becomes the deflation and the reality of paying the bill. Passive gains reverse into active fears after a decade of easy money. The data dependency of the FOMC clashes with the uncertainty of global politics and growth whether in China, Europe, UK or most emerging markets.    

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There are a number of key elections in 2019 – India is a case in point as the contrast of the China equity bear market and the absolute power of Xi contrasted in 2018 with the erosion of Modi’s power and the solid returns from India’s Sensex.  The risk of a coalition government in India in 2019 will be key along with the response of the RBI to oil deflation vs. currency weakness. 

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The European elections in 2019 are also important as they set up the leadership of the EU for many key positions with implications for Brexit, US trade, NATO, Russia, and Turkey. The problem is that the vote is likely to be less about winning over voters and more about apathy as the participation rate is expected to be low – opening up extremist views on both sides.

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The money to be made in 2019 from markets will be watching volatility and how that changes the equation of asset management processes and returns.  The world from 2009 changed with the ZIRP and QE policies driving a “TINA” (there is no alternative) to passive equity ownership. This chart from 2018 will be interesting to view at the end of 2019 as markets forcefully readjust to a world without a Powell Put.  The shift away from financial conditions to a more medium-term reactive Fed will drive up costs in managing money and drive down the risk/return ratios of passive investments. The limit of technology and speed of trading in a more diverse and regional world will also play a role. 

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The biggest risks for 2019 maybe not in the things we all have listed out as key fears but in the unknowns.  The global climate change risks leave clear that health and welfare of nations may be out of control for both politicians and central bankers. The most distressing and perhaps key chart from the FT for 2018 is the shift of pollution pain in India and China.  With over 10% of the world’s population suffering now, the longer term costs to healthcare and growth potential will be repriced.

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The balancing act for investors rests on how this see-saw plays out into 1Q2019 with positions already geared up for the worst case scenarios. The momentum plays suggest further tests of a bear market in the S&P500 to 2300 while the mean reversion and volatility make for another test of 2600 likely.  The 4Q earnings and 1Q growth will be the push and pull for the US equity market. 

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As for risk and the bigger picture globally, there is one barometer to watch that best describes the December pain and the 2019 gloom – AUD/JPY – as it historically foreshadows larger pain trades in carry, growth, and volatility. The 78-83 trading zone broke last week and for the month of December, this cross has moved 6.5%. The issue is whether we trade back to July 2016 lows and restart a 73-77 range or with hope beating fear 82-88 trading in later 2019.  

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Market Recap: The last week was one of volatility and holiday-thinned markets with Christmas driving most trading activity to trivial levels. However, there was some key news – 1) US government shutdown as Trump demands $5bn in funding for a Mexico border wall and the Democrats won’t budge.  2) US/China trade talk hopes rise – with Trump tweets and Xi comments. 3) China NBS Dec PMI manufacturing 49.4 from 50 – weaker than 49.9 expected – but services 53.8 from 53.4 – better than 53 expected. 4) Korea inflation for December 1.3% from 2% - less than 1.7% expected – reflecting oil and global growth. 5) German inflation flash for Dec 1.7% from 2.2% - also less than 1.9% expected. 6) Japan industrial production for November 1.4% from 4.2% y/y –as expected – while retail sales 1.4% from 3.6% y/y weaker than 2.2% expected and the unemployment rate rises to 2.5% from 2.4%. Also, Tokyo CPI for December core dips to 0.9% from 1.0% - suggesting BOJ will have to wait longer for its 2% target. 7) US Richmond Fed Manufacturing Survey -8 from 14 – weaker than 15 expected – matching weakness in NY and Philly Fed surveys but Chicago PMI for Dec 65.4 from 66.4 – better than 62 expected.  Also US conference board consumer confidence 128.1 from 136.4 – weaker than 134 expected. The weekly jobless claims were 216,000 from 217,000 – steady as expected and foreshadowing a reasonable jobs report next Friday. 

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Equities: The MSCI all-country World Index rose 1.78% to 452.69 on the week, off 8.4% on the month, off 13.3% on the year.  The MSCI EM index rose 0.55% to 962.63 on the week, off 3.33% on the month, off 16.55% on the year. 

• US S&P500 rose 0.74% to 2,485.74 on the week, down 7% on the month, down 7.3% on the year. The DJIA rose 0.89% to 23,062.40 on the week, off 6.40% on the month, off 6.8% on the year. The Nasdaq rose 0.86% on the week, off 7% on the month, off 5.45% on the year. The Cboe VIX fell 5.88% to 28.34 on the week, up 56.83% on the month and up 156.70% on the year. 
• The Stoxx Europe 600 fell 0.13% to 336.23 on the week, fell 5.95% on the month, off 13.6% on the year. The German DAX fell 0.7% on the week to 10,558.96, off 6.2% on the month, off 18.25% on the year. The French CAC40 fell 0.33% on the week to 4678.74, off 6.5% on the month, off 11.93% on the year. The UK FTSE rose 0.19% to 6,733.97 on the week, off 3.53% on the month off 12.41% on the year. The Italian FTSE MIB fell 0.4% to 18,324.03 on the week, off 4.51% on the month, off 16.15% on the year. 
• The MSCI Asia Pacific Index rose 0.66% to 146.03 on the week, off 5.17% on the month, off 16% on the year. The Japan Nikkei fell 0.75% to 20,014.77 on the week, off 10.45% on the month, off 12.08% on the year. The Hong Kong Hang Seng fell 0.97% to 25,504.20 on the week, off 3.78% on the month, off 14.76% on the year. The China Shanghai Composite fell 0.89% to 2,493.90 on the week, off 3.64% on the month, off 24.59% on the year.  The India S&P/CNX Nifty 50 rose 0.98% to 10,859.90 on the week, off 0.15% on the month, up 3.13% on the year.  The Korea Kospi fell 0.99% to 2,041.04 on the week, off 2.66% on the month, off 17.28% on the year.  The Australia ASX rose 3.3% to 5,716 on the week, off 0.58% on the month, off 7.32% on the year. 

Fixed Income: Bonds have rallied to reflect the uncertainty in equities, but they didn’t give up much even after the Wednesday post-Christmas rally.  The flatness of curves, expectations for an FOMC pause and lower oil mix with lower growth outlooks. 

• US 10-year bond yields off 8 bps to 2.74% on the week, off 32bps on the month but up 31 bps on the year still. Curve 2Y 2.54% off 10bps on the week, 3Y off 11bps to 2.52%, 5Y off 7bps to 2.57%, 30Y up 1bps to 3.04%.  
  Canada bond yields off 7bps to 1.96% on the week, off 35bps on the month and off 9bps on the year – BOC mistake fears rising – jobs key.
• Japan JGB yields off 4bps to 0.01% on the week off 8bsp on the month and 5bps on the year.  JPY 110 pivotal with equities.
• Australian bond yields off 3bps to 2.32% on the week, off 25bps on the month and 28bps on the years with a focus on China/commodities.
• UK Gilt yields off 6bps to 1.28% on the week, off 11bps on the month and up 3bps on the year even with the BOE hikes -Brexit and politics.
• German Bund yields off 2bps to 0.25% on the week, off 9bps on the month and 19bps on the year – with ECB ending QE/German growth.
• French OAT yields flat at 0.71% on the week, up 1bps on the month and off 9bps on the year – Macron and yellow vest crisis key.
• Italy BTP yields off 3bps to 2.75% on the week, off 40bps on the month but up 70bps on the year – politics/EU-budget battle, growth doubt.
• Spanish Bono yields up 2bps to 1.42% on the week off 9bps on the month and 15bps on the year – with focus on politics/growth
• Portugal bond yields up 3bps to 1.72% on the week off 11bps on the month off 27bps on the year – recovery vs. Italy.
• Greek bond yields up 4bps to 4.38% on the week, up 15bps on the month, off 46bps on the year – with a return to market key, politics

Foreign Exchange: The US dollar index 96.39 off 0.3% on the week, off 0.7% on the month, up 4.5% on the year. For the week– RUB fell 1.1% to 69.66 on oil, CNY rose 0.4% to 6.8780 with focus on talks, INR up 0.7% to 69.72 on oil, KRW up 1% to 1116 on trade/stocks, ZAR up 1.4% to 14.418, BRL flat at 3.8780 and MXN up 1.45% to 19.655. For the month – ZAR is off 4.7%, RUB off 3.8%, while MXN is up 3.1%, CNY up 1.1% and KRW up 0.6% 

• EUR: 1.1435 up 0.6% on the week– still watching 1.13-1.15 for momentum. ECB vs. FOMC key, for the month up 0.65% stuck. 
• JPY: 110.25 off 0.85% on the week and EUR/JPY off 0.25% to 126.15. All about risk and 109.50-112 again – with US rates key.  For the month, JPY up 3% with 114 now key resistance.
• GBP: 1.2705 up 0.5% on the week, EUR/GBP up 0.1% to .9005. All about EU/UK Brexit and politics still with 1.26-1.29 keys, still off 1.1% on the month with 1.25 vs. 1.30 risks.
• CHF: .9840 off 1.1% on the week– the return of safe-haven status with EUR/CHF off 0.5% to 1.1250 with focus on .98-1.00 for $ and 1.12 base for cross.  For the month off 1% with .9550 risk. 
• AUD: .7040 up 0.1% on the week and NZD .6710 off 0.1% - holding pattern watching RORO and China with .70 pivotal for .68 or .72 again.  For the month off 3.7% with .7350 key resistance.
• CAD: 1.3635 up 0.3% on the week with 1.3550-1.3700 next key range with oil/BOC driving, jobs this week key. For the month up 2.7% with 1.3450 base and risks for 1.38. 

Commodities: The S&P/GSCI was up 0.5% to 2219.08 on the week, off  7.6% on the month and 13.7% on the year. On the week, NatGas led the losers, off 11.9% on weather, with rice off 4.7% and Orange Juice off 3.4% while winners were Cocoa up 6%, Silver up 5%, Palladium up 2.1%. On the month, the winner is still Cocoa up 13.5%, then Silver up 6.8% and Gold up 4.3% while NatGas is off 27%, Coffee off 11.3% and Oil off 10.2%.  While the 2018 winner is Palladium up 13.2% and coffee is the loser of 28%. 

• Oil: $45.33 off 0.5% on the week, off 9.9% on the month, off 24% on the year. Brent fell 1.65% to $53.21 (March contract) on the week. Oil is firmly below $50 again and this opens the bigger $25 base risk again with $40-$50 consolidations expected in 1Q.
• Gold: $1279.90 up 2% on the week, up 5.6% on the month, off 1% on the year. Safe-haven of gold returns with market turmoil and USD doubts. Rates/Equities driving. 
• Corn: $375.50 off 0.8% on the week, up 4% on the month, up 6.8% on the year.  The role of US trade policy and Soybeans as the weapon of retaliation from China mattered more than good weather.
• Copper: $2.7315 up 0.5% on the week. Futures up 0.2% to $2.6790 on the week – but off 23% on the year and 3.75% on the month – the $2.55 level now key. 

Conclusions: Are we back to USD trading rather than the alternatives or oil or gold?  This is the 20th anniversary of the EUR.  Markets had doubts about the single currency for Europe from the start and they still do – just ask the British. The UK Brexit and the effects of the Italian budget battle haven’t helped confidence in the EUR in 2018 nor has the shifting political powers in France and Germany.  Markets have doubt about the USD as well with FOMC hikes in doubt, with US growth in doubt and US C/A deficits rising – the longer-term view is decidedly bearish for most analysts in 2019.  The trouble is the alternatives – with CNY far behind being a legitimate reserve currency, this leaves JPY, AUD, CAD, CHF, and GBP to offer up meager bond market alternatives.  So the pricing up of oil in EUR or CNY may be happening on the edges but not sufficiently to move the holdings of the USD in bonds or central bankers reserves.  Similarly, Gold which glittered in 4Q and December notably has yet to break out of its $1400 ceiling and remains an expensive safe-haven.  The USD rally that started with the Fed taper tantrum in 2014 and extended with Trump’s election hasn’t yet ended even with his best efforts to talk it down. The momentum for the dollar into 2019 is negative with 95 before 98 the general call but the risks of upside remain in play with 100 and the support in the medium term from 92-94 will remain on growth and rate differentials. 

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