January - March 2019

What 2018 means for 1^st QTR 2019

Asia Pacific – Rising Above the Trade War

Private Equity Outlook

The Secondary Market

What 2018 means for 1^st QTR 2019

Volatility returned in 2018 and likely will continue into 2019. It’s late in the cycle but we still see opportunities. Taking advantage of them will require discipline and a strong decision-making process.

For 2019, our strategists think it is too early to become overly defensive given that 2020 seems the recession danger zone for the United States. They are moderately bearish on government bonds as late-cycle inflation pressures emerge, more so outside of the U.S. given the low yields in the rest of the world.

The challenge is to make the most of late-cycle returns while preparing for a downturn. It means relying on a structured and disciplined process. Ultimately, it’s about assessing the value of the squeeze.

USA

Preparing for the descent

Fiscal stimulus supercharged the U.S. economy and corporate earnings in 2018. With that stimulus dissipating next year, we look for a sharp step-down in the growth rates that underpin U.S. assets. Recent market volatility has started to price in these risks. We don’t expect a major stumble in 2019, but we have entered the more dangerous phase of the economic cycle. Stay vigilant.

The view from the summit

Summiting a mountain can be an awesome experience, particularly on the way up when climbers are more inclined to pull out a camera for a photo or savor the view with a snack break. On the descent, though, the mood tends to change if the climber feels exhausted, behind schedule and eager for the downward move to end. The challenge in mountain climbing, as in finance, is to remain vigilant throughout, particularly on the way down when accidents are much more likely to occur.

Writing this outlook feels very much as though we are at the summit of the current U.S. expansion. The real GDP growth in the middle quarters of 2018 hit 3%.  Earnings growth for the S&P 500® Index has been 25% or higher in every quarter this year – a hair-raising pace usually only seen in the bounce out of recessions. And the U.S. Bureau of Labor Statistics shows the unemployment rate stands at a 49-year low. U.S. fundamentals are unequivocally strong right now. The problem is that we think this is as good as it gets for the cycle.

The 2018 midterm elections resulted in a gridlocked Congress. And, given the polarization of U.S. politics today, that outcome all but guarantees no new material tax cuts or spending packages are likely to be enacted through 2020. Furthermore, members of the Federal Reserve’s Board of Governors – while they’re not there yet – are talking about the need to transition monetary policy into a restrictive setting to ensure the U.S. economy doesn’t overheat. By our estimates, this means that U.S. real GDP growth should mechanically slow from 3% in 2018 to around 2% next year. This cresting of domestic economic activity levels, the punitive base effects from the corporate tax cuts, and accelerating input costs point to an even sharper slowing in U.S. earnings growth from 25% to 8% in 2019.

What we are left to assess is the impact of the slowdown on asset prices. The good news is that the market has already started to do some of the heavy liftings for us. The volatility that we saw in October and November was very much a re-rating of the outlook. Over the last month, industry consensus earnings growth estimates for the S&P 500 Index in 2019 have been marked down from 10.5% to 9%. Those downgrades have been particularly concentrated across mega-cap U.S. technology stocks.

We view the recent selloff more as a healthy retrenchment in investor sentiment than being indicative of an imminent collapse in the U.S. economy. For example, the downgrades to Apple’s stock in the fourth quarter appear to be driven by concerns about the order book for their latest model of iPhones. These are BIG businesses, but their problems appear idiosyncratic in nature (for now). We also see the U.S. and global consumer in a robust position as 2018 ends with strong income growth, declining unemployment rates, and confidence. However, we’ll remain vigilant.

We see greater downside risk to the macro outlook as we peer into the early part of 2020. By then our expectation is that the yield curve will have already inverted, the Fed will have transitioned its monetary policy to a restrictive setting, and the tailwinds from tax cuts and increased government spending will have been fully exhausted. Coupled with what are still expensive valuations in U.S. equities, we are operating as risk managers rather than risk takers. Over the last 50 years, U.S. equities have never peaked more than 13 months before an economic recession. If our timing is roughly right in terms of when those macro vulnerabilities manifest, it’s still too early for the equity market to have peaked. As such the path of least resistance looks higher. Still, we’ve entered a very risky phase of the business cycle.

Regarding interest rate markets, we feel quite confident the Fed will keep hiking in the face of recent market turbulence, particularly since its dual mandate of full employment and price stability has effectively been achieved. For a central banker, that means it’s time to get interest rates back to normal levels. And if our forecast for gradually accelerating inflationary pressures is right, it will also be time to take the punch bowl away. We forecast a rate hike in December 2018 and three to four hikes in 2019. Fixed income markets have turned more pessimistic in recent weeks. As such our Fed call leaves us with a bias for a flatter curve and modestly higher rates tactically. However, with recession risks lurking in 2020, our 12-month ahead forecast of the U.S. Treasury yield is still hovering around 3% and it’s likely to be a bumpy journey to that target.

Conclusion: We maintain a modest underweight preference for U.S. equities in global portfolios, primarily on the back of their expensive valuations.

Eurozone

The deceleration in European growth in the third quarter of 2018 was mainly due to temporary factors in the auto industry, and we believe GDP should rebound from here. However, Italy needs to resolve its budget stand-off with the European Commission to unlock the value in Eurozone equities.

Transient and recurrent headwinds

Eurozone economic growth slowed sharply from a quarterly pace of 0.7% in Q1 2018 to 0.2% in the three months ending in September. A significant part of the deceleration was probably due to transient factors, in particular a drop in car production after a change in environmental regulation. The German Federal Ministry for Economic Affairs and Energy estimates the switch to the new regulations depressed German GDP by up to 0.4% quarter-on-quarter in Q3. A reversal of that special effect should help Eurozone GDP to rebound in late 2018 and into 2019.

Italy has become a greater risk for Eurozone prospects over recent months. The new coalition government between the left-leaning Five Star Movement and right-of-center League political parties submitted a draft 2019 budget that was badly received by bond markets. A proposed budget deficit of 2.4% of GDP was three times that targeted by the previous government. In response to Italy’s perceived laxity, the European Commission initiated an “excessive deficit procedure”, a mechanism designed to rein in profligate euro-area member countries.

Conclusion: Investors may be forgiven for growing wary of the many head fakes that the European equity markets have dealt them. According to the Bank of America Merrill Lynch Fund Manager survey published on November 13, a majority of participants seem to have thrown in the towel and are now below their average historical allocation to Eurozone stocks. From a contrarian perspective, that bodes better for the asset class. We remain constructive on Eurozone equities, especially relative to the U.S. market.

Asia Pacific

Rising above the trade war

The region should see another year of GDP growth in the 4.5-5.0% range, and we expect China and India will be the major contributors. Equity markets in the region are good value as 2018 ends, and we confidently predict that earnings growth will meet market expectations in 2019. A key risk for the region is trade tensions. However, we do not believe this will derail the growth outlook.

Looking toward to another solid year for the Asia-Pacific region, we expect emerging Asia to deliver more than 10% earnings growth, while Japan is well-placed to exceed modest industry consensus expectations. Politics will be a key theme for the region, with elections to be held in India, Indonesia, the Philippines, and Australia. The outcome of trade negotiations between the U.S. and China remains the key risk.

China should be able to deliver GDP growth of 6%. The economy faces headwinds of high indebtedness, slowing property construction, poor demographics and a confrontational U.S. stance on trade. However, we think the stimulus from the Chinese government and work surrounding its infrastructure-focused Belt and Road Initiative will mitigate these concerns.

Indian economic growth is expected to remain around a very healthy 7.5% in 2019, driven by household consumption and some solid capital expenditure. The general election is set for March 2019, and opinion polls held in late 2018 by Indian agencies indicate it is going to be a close race. This could incentivize some pre-election spending promises and some corresponding upside surprise. On monetary policy, we expect the Reserve Bank of India to keep rates on hold.

The South Korean economy should maintain a decent growth rate of 2-3%, with some fiscal stimulus in the form of higher social spending likely. With GDP growth running close to potential, and inflation close to the target, we are likely to see the Bank of Korea raise rates at least once through 2019.

Australian growth is likely to slow, albeit still above trend. The key focus for 2019 is going to be the housing market, given elevated prices are starting to slip, household indebtedness is high, and the tax regime for housing is likely to tighten. While this is a risk for the economy, there is a large pipeline of infrastructure work in place, the labor market is expected to remain strong, and support is expected to come from commodity prices. With inflation and wages gradually rising, and the labor market at full employment, we think the Reserve Bank of Australia will have the scope to raise rates once in 2019.

The New Zealand economy continues to face the challenges of falling population growth, a slowing housing market and depressed business confidence, which is being driven by uncertainty around future government policy. We don’t expect the Reserve Bank of New Zealand to make any monetary policy changes in 2019, while we will be closely watching the 2019 federal budget for signs of less fiscal spending from the Labour Party-led government.

Japanese growth should see a boost from reconstruction efforts following a year of natural disasters in 2018, along with construction work ramping up for the 2020 Olympics. The extremely tight labor market should provide a boost to consumption (as wages start to rise), as well as capital expenditure (as firms try to improve labor productivity). Our key watchpoint will be the consumption tax hike that is scheduled for October 2019, which has the potential to elicit some front-loading in the lead-up, followed by a fall-off. We expect Japanese bond yields will gradually edge up from a very low base, as inflation continues to slowly move higher.

An escalation of the trade war remains a key risk to the region, as a slowdown in China would have large knock-on effects given the interconnectedness of Asian trade. Our central case is that this would slow, but not derail, regional growth.

Conclusion: Our outlook on the region for 2019 remains cautious, but positive, given decent economic fundamentals and good value. Risks around a trade war remain a headwind, however there is always opportunity in adversity and as our investors find the Hang Seng to be a very solid trading board with plenty of exciting opportunities through the way Global Business Brokers conduct our business.

Private Equity Outlook

2018 was a banner year for private equity. As of late December, PE buyout volume had reached almost $384 billion, the highest since the PE boom before the financial crisis. The pace of activity overcame various macro challenges to PE dealmaking, including competition from strategic acquirers, high-multiple valuations and, in the fourth quarter, rising interest rates and disruption in the high-yield and leveraged loan markets.

How did financial sponsors succeed in a volatile and uncertain environment?

Many of the larger transactions depended upon strategic partnerships. Blackstone, for example, partnered with Thomson Reuters to carve out its financial and risk business into a $20 billion strategic venture owned 55% by Blackstone and its co-investors and 45% by Thomson Reuters. One high-profile activist’s willingness to take more long-term risk supported major PE deals—Veritas’ and Elliott Management’s pending acquisition of Athenahealth and Siris Capital Group’s and Elliott Management’s pending acquisition of Travelport. Whereas activist hedge funds have often advocated for target companies to sell, including to PE firms, it remains to be seen whether other activist hedge funds will also be willing to partner as co-buyers with PE firms.

Sponsors also built transactions based on their relationships with owners of private firms and public company CEOs. In these bespoke public target situations, to retain the “first-mover” track, PE firms often accepted, or even proposed, “go-shop” provisions to address concerns about the absence of a more full pre-signing market check (about 20% of private-equity deals in 2018 had a go-shop provision).

In the private M&A setting, representation and warranty insurance is now firmly established as a tool to facilitate a clean exit for PE sponsors, while providing the buyer with protection akin to a post-closing indemnity. Likewise, we find PE firms considering R&W policies when acquiring public companies, which supports dealmaking on the buy-side through the possibility of some post-closing protection. While R&W policies vary in scope, policy forms have become more standardized, pricing has become more competitive, the time required to obtain a policy has become more streamlined and substantial insurance coverage is available in the market. In addition, whereas in the past carriers generally required sellers to have some “skin in the game,” in the form of a limited indemnity obligation, we have seen more recently R&W policies where carriers retain all risk, above a negotiated, de minimis deductible.

Fundraising in 2018 remained strong by historical standards, but down from the elevated levels of 2017, the highest since the financial crisis. As in 2017, fundraising was concentrated in a relatively small number of large funds raised by established PE firms. With over $1 trillion of total dry powder in PE funds, deal equity capital supply is more than ample.

We enter 2019 in a period of significant uncertainty across a variety of macroeconomic, geopolitical and financial factors, with accompanying substantial volatility in equity and debt markets. Such an environment tends to chill strategic deals, and makes other deals more difficult.

However, we expect that our nimble and innovative financial contacts and network will find opportunities even in these challenging conditions, or in fact because of them. In adversity, opportunity arises so expect Global Business Brokers to find some diamonds in the rough throughout 2019 for our buyers and sellers. We once again have a number of statutes of limitations from loans to companies who paid the respective banks back in shares to become a reality this year and these opportunities have served us well over the years.

The Secondary Market

The beauty of the secondary market is that when a corporation, fund, trust or bank own large amounts of stock spread over various investment vehicles, there comes the time to want to cash in on profit but also the necessity due to certain statutes of limitation to have to cash in on profit or loss.  Using the open market runs the risk of adversely affecting the market price if large amounts of stock are traded, especially if the selling entity owns more of the particular stock spread over different investment vehicles.

This is where Global Business Brokers come in and facilitate.

We also have many private clients that at some stage need liquidity from certain individual positions and have various reasons for using Global Business Brokers and not dealing with high street brokerages, we are able to facilitate this by offering positions to our equity buyers and also to new prospective clients.

The secondary market is thriving and as our client base grows so does Global Business Brokers reputation for being a reliable source to buy and sell quickly.

Our model revolves around the fact that we are able to buy ‘Publicly traded stock in a private capacity.’

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