By Jeffrey Kleintop
- Global growth is likely to slow as the economic cycle nears a peak.
- Trade tensions, inflation and interest rates are key indicators to watch as financial conditions tighten and act as a drag on markets and the economy.
- Watch the gap between unemployment and inflation rates, along with the yield curve, for signs of a peak in economic growth ahead of a potential recession.
Global growth may slow in 2019 as the economic cycle nears a peak, with increasing drag from worsening financial conditions combining with full employment and rising prices. Global stock markets may peak in 2019 if leading indicators signal the gathering clouds of a global recession.
If we borrow the severe weather scale for storms and apply it to the global economy and markets, we aren't forecasting "Recession Warning," meaning a recession is here or imminent. A better term is "Recession Watch," in which conditions are favorable to a recession if a number of risk factors (e.g., trade, interest rates, inflation) deteriorate.
While trade tensions have the potential to inflict substantial damage on the world economy, it would require a significant escalation from the measures implemented so far to trigger the next global recession.
Indicators may point to stock market peak
For all the concerns about trade policy, Brexit and other issues, 2018's big stock market declines generally were driven by inflation and interest rate concerns. These are the indicators investors should watch most closely in 2019.
Historically, when unemployment and inflation rates have converged to become the same number, signaling an overheating economy, it has marked the beginning of a prolonged downturn for the stock market, followed about a year later by a recession. The gap between the unemployment rate and the inflation rate is close to one percentage point in major countries like Germany, Japan, the United Kingdom, and the United States. Another leading indicator, the yield curve, also has shown a narrowing gap between short- and longer-term Treasury yields. These gaps may close in 2019 and signal a peak for international stocks ahead of a global recession.
International stocks may continue to see heightened volatility and could enter a bear market if key indicators continue on their current path.
Consider reducing portfolio volatility by trimming, historically, more volatile asset classes, such as emerging market stocks.
Consider rebalancing back to long-term asset allocation targets. Historically, long-term asset class trends have tended to reverse in the year prior to global recessions and bear markets. This may begin to favor international over U.S., value over growth, and large- over small-cap stocks.