CS Investment Outlook 2019 en

Investment
Outlook 2019
An extended cycle
Investment Outlook 2019
An extended
cycle
credit-suisse.com/investmentoutlook 3
Letter from the CEO
From my
perspective
Tidjane Thiam
CEO Credit Suisse Group AG
As I present our Investment Outlook 2019, a year that

turned out to be much more eventful than we all expected
is drawing to a close. Political events have had and
continue to have a major impact on financial markets.
Global trade terms are being reshaped: tariffs, something Innovation is another key value at Credit Suisse. Our House
we had grown accustomed to not thinking about, are back View also encompasses our five Supertrends: “Angry soci-
with some governments introducing tariffs and other protec- eties – Multipolar world,” “Infrastructure – Closing the gap,”
tive measures for some of their trading partners. We have “Technology at the service of humans,” “Silver economy,”
also seen new regional trade arrangements reached. In and “Millennials’ values.” They provide compelling themes
the past year, I have often discussed these important devel- for long-term investors (see pages 34 – 37 for details). I
opments with clients and other stakeholders. In doing so, I would like to emphasize sustainable investments this year,
have been able to rely not only on my own experience, but included in one of our Supertrends, as this is an area of
also on the Credit Suisse House View. increasing interest for our clients today and of growing
relevance for our world. We at Credit Suisse are committed
The House View plays a fundamental role in shaping the to playing our part in making our collective investments
advice we give our clients and how we invest on their behalf. sustainable, which we believe is also smart investing.
Our leading investment strategists analyze global political
The House View is an

and economic trends, and distill a wide range of analysis and I wish you a prosperous 2019.
information from across the bank into one consistent view.
In short, the House View is an essential part of the trust we Tidjane Thiam
essential part of the

earn and the results we deliver.
trust we earn and the

results we deliver.
4 Investment Outlook 2019 credit-suisse.com/investmentoutlook 5
Overview
Contents 04 Letter from the CEO

08 Editorial
10 Review of 2018
12 Key topics 2019
58 Calendar 2019
14
Global economy
34
Special
38
Financial markets
16 Stimulus fades, but growth remains 34 Supertrends 40 Positioning for late cycle growth
20 What makes the business cycle go round (Spotlight) 35 Smart sustainable investing 45 US yield curve inversion: Do we need to worry? (Spotlight)
22 World follows US Fed’s tightening path 36 Impact investing 46 The sector standpoint
25 Proclaiming the demise of globalization may be premature (Spotlight) 50 The state of play for currencies
26 The global economy’s stress test 53 The twin deficit – boon or bane for the USD? (Spotlight)
32 Regions in focus 54 Investment themes 2019

Editorial
An extended cycle
Michael Strobaek Global Chief Investment Officer
Nannette Hechler-Fayd’herbe Global Head of Investment Strategy & Research
Most years have a dominant theme that shapes financial

markets. In 2017 it was the Goldilocks economy – not too hot,
not too cold – and the return of politics as a market driver.
Trade conflicts and interest rate concerns dominated 2018.
Going into 2019, we believe that a significant focus will be
on the factors that can prolong the economic cycle.
Our Investment Outlook 2019 provides a roadmap to Last but not least, our special focus section is devoted to
navigate the months ahead. For equities, we provide an what has excited us most in the last two years: our long-
overview of all sectors. We believe that technology will term Supertrends, five investment themes that offer
remain a strong driver. For fixed income, we examine the superior return prospects. Furthermore, we showcase
relatively rare phenomenon of a US yield curve inversion education as part of our efforts in sustainable and impact
(when US short-term interest rates exceed long-term investing, a market that has been seeing rapid growth as
interest rates). And we discuss how to establish a investors increasingly seek to combine financial returns with
successful currency strategy comprising carry, value and a social and environmental impact.
safe-haven currencies.
We wish you a successful year ahead.
From the macroeconomic point of view, several factors may
well prolong the economic cycle and speak against an
imminent global slowdown. Productivity gains and benign
A significant focus will be on

inflation will be key for central banks’ monetary responses
and hence financial markets.
the factors that can prolong

the economic cycle.

Review of 2018 political developments &
global security
2018: The year

elections
(presidential & parliamentary)
industry &
corporations
monetary &
when trade shifted
banking system
energy
(oil)
09 January 27 April 30 August 13 September 30 September

Tightening talk in Japan Peace hopes in Korea 13 June Rates jump in Argentina Turkish rates rise New trade agreement
22 January
The Bank of Japan reduces The leaders of North and Fed hikes rates The peso declines, and Turkey’s central bank hikes Canada and the USA
Trade conflicts begin
its purchase of super-long South Korea agree to seek The US Fed raises its Argentina’s central bank hikes the key interest rate to 24%, announce a new trade
The USA unveils tariffs on
bonds; speculation about 16 March talks to reach a peace treaty benchmark short-term interest rates to a new high of taking some pressure off agreement to replace NAFTA, 30 November
imported washing machines
further monetary tightening Tech sell-off and end a d ecades-long interest rate by a quarter 60% in response. the TRY. a month after the USA G20 Summit in
and solar panels, a move
sends bond yields higher. The Nasdaq falls, beginning conflict. percent. reached an agreement Buenos Aires
criticized by China and
an 11% decline during the with Mexico. The two-day annual summit
South Korea.
month of March, sparked of G20 leaders takes place
by data privacy concerns in Argentina.
surrounding social media
companies. 06 July
Trade spat deepens 17/18 October
US President Trump imposes EU Council meets
tariffs on USD 34 bn of Quarterly EU summit focuses
01 June Chinese products. China on migration and internal
02 February Shifting Italian politics responds with its own tariffs security, and the state of
Repricing Fed expectations New populist Italian on US goods. Brexit talks. 30 October
22 March government leads to only Shift in German politics
1240 Equity markets in broad
Trade tensions continue temporary relief in markets German Chancellor Angela
Pts. sell-off as strong US wage
US President Trump imposes after a significant sell-off. Merkel announces her
data leads to a repricing of
tariffs on USD 50 bn of step-by-step withdrawal from
US Federal Reserve rate hike
Chinese imports. The next politics.
expectations. 28 October
1220 day, China unveils tariffs on
Pts. USD 3 bn of US imports in Brazilian elections
response to the US tariffs Conservative Jair Bolsonaro
on steel announced a few wins Brazil’s presidential
weeks earlier. election.
MSCI AC World total return index

(gross local returns)
02 August
Apple wins the race
Apple becomes the world’s
first publicly-traded company
to reach a trillion-dollar 06 December
market valuation. 175th OPEC meeting
OPEC to discuss production
strategy and long-term
01 January
cooperation with Russia.
US tax reform
1140 The US Tax Cuts and Jobs
12 June 09 July 24 September
Pts. Act, which reduces corporate
16 February 08 May US/North Korea summit Turkey in crisis News from the European
tax rates, goes into effect at
USA targets steel Credit for Argentina US President Trump meets The TRY slides on concerns Central Bank (ECB) 06 November
the beginning of the year, 01 August
The USA proposes large Argentinian President with North Korean leader about its current account and ECB President Mario Draghi US mid-term elections
fueling investor optimism and USA mulls more tariffs
1120 tariffs on steel and aluminum Macri asks the International Kim Jong-un in Singapore. budget deficits as President expects a “relatively vigorous” The Democrats regained a
helping push the stock for China
Pts. imports from nations around Monetary Fund for a loan Erdogan tightens his grip on increase in Eurozone inflation, majority of seats in the House
market to new highs. The USA considers raising
the world. as the economy struggles the central bank. putting upside pressure on of Representatives, while the
the proposed level of tariffs bond yields.
with high inflation and Republicans remain in control
on an additional USD 200 bn
a plunging peso. of the Senate.
1100 worth of Chinese imports.
Pts.
Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec.

Key topics 2019
Drivers likely to The best of all

worlds is a fairly
extend the cycle stable USD.
From technology and USD stability to emerging
markets rebalancing, we review six key market
drivers and risks in 2019.
Keeping inflation under control US dollar stability China’s resilience Calmer European politics Emerging markets rebalancing Tech and healthcare innovations
Growth momentum in advanced Gyrations of the USD tend to desta US trade policy is putting consider- Eurozone growth is expected to Emerging markets (EM) entered the Technology stocks have been the
economies seems strong enough bilize the world economy and financial able strain on China. Moreover, after remain above potential in 2019, financial crisis with fairly healthy dominant driver of global equity
to extend the cycle into 2019 and markets. USD strength, as seen in H1 the USA recently renegotiated trade thanks in part to still loose monetary balance sheets. After 2008, cheap markets in the past decade. The MSCI
beyond. The more important question 2018, can put severe strain on econo- agreements with Mexico, Canada and conditions. We expect political USD funds seduced EM, especially World IT sector has outperformed the
for markets is whether inflation will mies that require cheap dollar funding. South Korea, and amid de-escalating stresses to calm down to some corporations, to substantially boost overall market by approximately 200%
remain as benign as it has been. If Significant USD weakness puts pres- trade tensions with Europe, the US extent. The exit of Britain from the their foreign currency borrowing. Yet since March 2009. Social media,
inflation rises significantly more than sure on export champions, such as trade stance towards China could European Union (EU), slated for 29 with the costs of USD liquidity rising in online shopping and ever more elabo-
markets (and we) currently expect, Germany and Japan. It also raises the harden further. China’s patience is March 2019, should not do much 2018 as a result of a more hawkish rate hand-held devices have taken
the US Federal Reserve (Fed) will be specter of inflation as commodity thus likely to be additionally tested. If harm to either side if handled wisely. Fed, stresses emerged and some EM the world by storm. An important
seen as being behind the curve. Bond prices tend to rise sharply in response its policymakers proceed cautiously, In Germany, the ongoing political currencies suffered severe setbacks. question for investors is whether
yields would further increase signifi- to a weak USD. The best of all worlds as in 2018, risks of instability should realignment is unlikely to cause At the end of 2018, there were indi growth in this sector will remain this
cantly, while equities and other risk is a fairly stable USD. With Fed tight- be limited and the expansion can be instability, as the influence of the cations that internal and external strong, with the emergence of new
assets would likely decline substan- ening well advanced, and the extended. Aggressive currency policy, extreme parties remains limited. balance was being restored, in part with areas of focus such as virtual reality
tially. Barring an unlikely surge in European Central Bank as well as the credit easing or foreign policy, would be Meanwhile, we believe that Italy and the support of the International and artificial intelligence. A second
productivity, wage growth will be the Bank of Japan gradually catching up, destabilizing, however. the EU will ultimately find a compro- Monetary Fund. If that process contin- key sector that is likely to influence
key driver of inflation. chances are good that the USD will mise over the country’s budget ues in 2019, EM can recover and the fate of equity markets is health-
indeed be stable. deficit while reaffirming Italy’s euro global investors would benefit. care, with investors keeping an eye on
membership. gene therapy and other innovative
treatments.

Global
economy
In short
Different growth tracks
The impact of US fiscal stimulus will likely peak in the course of 2019, but growth should remain
above trend on the back of robust corporate capital expenditure, hiring and wage growth. In China,
however, we are likely to see growth slow towards 6%. US tariffs, sluggish manufacturing investment
and slowing consumption growth are likely to act as constraints. In Europe and Japan, still lax
monetary conditions should help maintain moderate growth momentum. But in a number of emerging
markets, growth looks set to remain subpar as policymakers focus on inflation and currency control.
Inflation on the move

Notwithstanding higher capital spending, capacity constraints are likely to tighten further in most
advanced economies. Given declining unemployment and intensifying labor shortages, wage growth
should continue to pick up. Despite a moderate recovery of productivity growth, core inflation is thus
likely to gradually move higher, with commodity prices an upside risk. Central banks will continue to
respond in varying degrees, depending on domestic and external constraints.
Eye on emerging markets

How high is the risk of renewed economic and financial instability? In many advanced economies,
not least the USA, the unsustainable trajectory of government debt is the major longer-term risk.
However, barring instability in Italy, a crisis seems unlikely because household and bank balance
sheets have improved since 2008, while corporate balance sheets have only modestly deteriorated.
In China, high debt levels should slow growth rather than spark a crisis. Stress is more likely
to resurface in financially fragile emerging markets.
Global economy Stimulus fades, but growth remains
Stimulus fades, but A resolution of the trade

conflicts would support
growth remains business confidence,
The impact of US fiscal stimulus is likely to fade, but “easy
investment spending and
money,” healthy capital expenditure as well as continued
employment and wage growth should extend the cycle in
growth.
advanced economies. Growth in China is set to slow further
as policymakers opt for stability rather than strong stimulus.
The synchronized global expansion of 2017 gave way to a Fiscal stimulus reduced
disparate growth picture in 2018. After weakness at the Our base case for 2019 sees a moderate slowdown in
start of the year, US economic growth accelerated substan- global GDP growth relative to 2018, chiefly due to fading
tially on the back of cuts in corporate and personal taxes. In policy stimulus in the USA and policy tightening in EM
China, GDP growth held up better than expected despite ex-China (see forecast on page 31). While certain aspects
government measures to rein in excess credit growth. As of the US tax reform should continue to enhance household
the US Federal Reserve (Fed) turned more hawkish in the cash flows and remain supportive for companies, the
spring of 2018, stresses began to appear in various impact of US fiscal stimulus is set to diminish. Across other
emerging markets (EM), most prominently Argentina and advanced economies, we expect fiscal policy to be largely
Turkey. To protect their currencies from further deprecia- neutral apart from minor stimulus in Japan, and possibly the
tion, a number of EM central banks tightened policy, Eurozone. In contrast, many EM governments will likely be
significantly weakening growth momentum. The weaker forced to tighten fiscal policy.
external demand from EM is likely one of the reasons why
growth in the Eurozone moderated in the first few months In most advanced economies, monetary policy remains
of 2018. fairly loose compared to both the pre-crisis years and much
of the post-financial crisis years. It should remain accom-
modative in 2019 even with further normalization, despite a
number of rate hikes. US monetary policy is still not
particularly tight (see chart on page 18). Yet in 2019, it
should gradually dampen US growth even if its impact may
once again be greater in EM given the key role USD
liquidity plays for many of these markets.

Global economy Stimulus fades, but growth remains
Companies keep investing

Barring a significant worsening of the global trade conflicts Consumer spending China in a holding pattern
China’s strong foreign asset position and low inflation give
Upside and downside risks
Of course, there are both downside and upside risks to our
– or other triggers of greater uncertainty – we expect
corporate capital expenditure (capex) to continue to expand should remain robust its policymakers more leeway in their actions than in many
EM. At the same time, given the high debt levels of
base case. On the downside, country-specific issues such
as Italy’s fiscal situation might weaken Europe’s growth
in 2019. The need to adapt supply chains in response to
tariffs may itself trigger some investment spending. in most advanced state-owned companies and local governments, Chinese
policymakers are likely to refrain from returning to aggres-
outlook. A sharper-than-expected slowdown in China would
most affect other Asian economies, but would also impact
Corporate investment is key to extending the cycle as
government stimulus fades. economies. sive credit stimulus. Instead, they are likely to do just
enough to prevent US tariffs from significantly depressing
Europe. Significant setbacks in financial markets (e.g.
triggered by an unexpected rise in inflation and subsequent
growth. They are also unlikely to opt for significant RMB fears of faster monetary policy tightening in the USA)
In late 2018, business optimism remained strong, especial- depreciation. Meanwhile, the contribution of household could hurt confidence. However, a resolution of the trade
ly in the USA, while capacity constraints were still tighten- Finally, claims that companies that buy back stocks have spending to growth will be constrained because mortgage conflicts would support business confidence, investment
ing and funding conditions remained benign. Many compa- less funds for capex do not hold up to closer scrutiny – at debt and debt service (almost 30% of household income, spending and growth. It would also provide new impulses
nies are likely to further expand their market share in 2019, least not in the USA. In fact, a bottom-up study of the S&P according to our estimates) have increased substantially on for an extension of the expansion.
be it via capex or mergers and acquisitions. Growth 500 universe by Credit Suisse analysts demonstrates that the back of rising real estate prices. Although China’s
companies generally have healthy balance sheets and the two activities, which both reflect balance sheet growth rates remain far above the global average, its
strong cash positions. Moreover, high energy prices are strength, correlate positively. Given high and still rising contribution to global growth will probably flatten or even
likely to be supportive as well given the continued impor- employment rates and accelerating wage growth, consumer decline after the 2017 recovery (see chart below).
tance of energy-related capex. spending should also remain robust in most advanced
economies. Our outlook for growth in other EM remains more cautious,
though there are significant differences across countries.
In countries with vulnerable external balances, the setbacks
of 2018 are likely to extend into 2019 as policy continues
to focus on currency stabilization. Political uncertainties will
add to downside risks in a number of countries. Meanwhile,
in countries such as Russia, higher commodity export
revenues should offset pressure from tighter USD liquidity.
Monetary policy still loose in advanced economies China’s high growth contribution likely to diminish
Central bank rates minus nominal GDP growth (in % points*) Real GDP growth of China (in %) and contribution of China to global GDP growth
(in % points, using purchasing power parity measures)
20
16 4.0
15
14 3.5
Tighter
10
policy
12 3.0
5
10 2.5
0
8 2.0
-5
Looser
policy
6 1.5
-10
-15 4 1.0
-20 2 0.5
JPN FRA ITA GBR CAN USA AUS GER CHE SWE BRA SAF MEX RUS KOR IND IDN THA CHN TUR 1994 1998 2002 2006 2010 2014 2018
* Each point shows a quarterly value between Q1 2005 and Q2 2018 Q2 2018 advanced economies Last data point 2017 Real GDP growth of China
Last data point Q2 2018 2018 Credit Suisse estimate
Q2 2018 emerging economies Source World Bank, Credit Suisse China’s contribution to world GDP growth (right-hand scale)
Source Federal Reserve Bank of St. Louis, Thomson Reuters Datastream, Credit Suisse

Spotlight A key risk is that the
positive impact of US
What makes the business demand fades and
cycle go round there is nobody to take
Long-term growth trends and business cycle fluctuations
have a significant impact on financial markets. This Invest-
USA in driver’s seat
Although the US economy is relatively closed in terms of
over the baton.
ment Outlook focuses mostly on the latter. international trade, it is a key driver of the global business
cycle. This is likely because US policymakers are more
Shocks drive manufacturing cycles focused on stabilizing employment and domestic consump-
Business cycles are driven by fluctuations (shocks) in tion than other countries, and because their decisions have
aggregate demand or aggregate supply. The most common a stronger impact on the global economy via financial
supply shocks result from sudden changes in the cost of markets. In all but one period (the aftermath of the financial
widely used raw materials, especially oil. Aggregate crisis), the USA has been a positive driver of the global
demand shocks result from shifts in monetary or fiscal business cycle (see chart on page 21). The Eurozone’s
policy, which stimulate or restrain private spending. impact has been much weaker, except in the pre-2008
Excesses or shortages of manufacturing inventories also boom. Since then, the region has been a major drag on the
trigger business cycle fluctuations by affecting the momen- global business cycle. China only provided a cyclical boost
tum of industrial production (IP). Our economists note that in the years after 2008. Looking ahead, a key risk is that
global IP typically slumps every 3 – 4 years, a pattern visible the positive impact of US demand fades and there is The USA has been the dominant stimulator of global aggregate demand
in US and UK data since the 19th century. While such nobody to take over the baton. Changes in net spending in USD bn (annual averages for sub-periods)
slumps corresponded with overall recessions up to the early
1980s, this is no longer the case, probably because the
100 USA
weight of manufacturing employment in the economy has
China
declined and countercyclical monetary policy has become
80 Eurozone
more effective. Given that 2015 was the most recent slump
year, our risk scenario is for the next phase of global IP
60
weakness to occur in late 2019 or 2020.
40
20
- 20
-40
-60
-80
1998 – 2001 2002 – 2008 2009 – 2013 2014 – 2018
Last data point 2017 Note National income accounting shows that changes in the current account balance of a country correspond to
2018 International Monetary Fund estimate the sum of changes in spending by households, companies and the government of that country. An increase in
Source International Monetary Fund, spending (reduced saving) increases the current account deficit, and vice versa. This chart shows the change in
Credit Suisse current accounts (with positive numbers indicating a worsening current account balance) and can thus be seen as
an approximation of the demand impulse that a country provides to the rest of the world.

Global economy World follows US Fed’s tightening path
World follows US The evolution of inflation in the major economies, especially in the services sector. However, labor shortages in these
the USA and the Eurozone, will be a key driver of financial areas seem to have increased quite significantly as well,
markets in 2019. Upside inflation surprises pose a greater and company-level evidence suggests that wage gains are
Fed’s tightening path
risk to bond and equity markets than limited disappoint- accelerating.
ments in economic growth. January 2018 was a case
in point, as a minor upward surprise in US wage inflation Beware the inflation jokers
triggered the year’s largest correction in equities. Wage inflation does not translate directly into price inflation.
Other costs, including interest expenses and input costs
More money in workers’ pockets (especially for raw materials such as oil) are key drivers of
According to our base case, core inflation will rise modestly headline inflation. The significant increases in oil prices in
in the USA, Eurozone and several other developed econo- 2007 and 2008 as well as in 2011 were the main reason
Our base case foresees a gradual rise of inflation in advanced mies in 2019 as capacity constraints tighten. By late 2019, why headline inflation rose at the time. If our global growth
economies and fairly stable inflation in emerging markets, unemployment rates in the USA and Europe will likely
approach 20-year lows. Labor markets are tight in Germany,
scenario holds, the price of oil and other cyclical commodi-
ties could rise further in 2019. Interest costs are also likely
albeit with significant dispersion. We expect monetary policy the UK, Switzerland, Canada and Australia. Even Japa- to creep up. Given strong final demand growth, the share of
to continue to tighten globally, but at a moderate pace. nese wages are now rising after declining for most of the past
two decades. That said, the absolute rate of wage gains is
costs absorbed by corporate profits is unlikely to rise, as
such increases typically occur when demand is weak. While
still well below pre-crisis highs, including in the USA. Yet we expect labor productivity measures in the USA and other
barring an unforeseen economic shock, we believe labor developed markets to move higher, we do not believe this
markets should continue to tighten, pushing wages up further. will markedly dampen inflation. In summary, with average
Academic literature has suggested that wage gains have inflation in advanced economies already close to the
been more subdued since the financial crisis due to the previous mid-cycle period (2004/05) levels, a further
increased buying power of large corporations, especially increase in inflation seems likely (see forecast on page 31).
Inflation in developed markets is back at pre-crisis levels

Consumer price inflation for ten major developed markets* and eight major emerging markets** (quarterly data %);
line shows average, shadows show +/- one standard deviation.
14
12
10
2005 2007 2009 2011 2013 2015 2017
Last data point Q3 2018 * Developed markets: Developed markets

Source Thomson Reuters Datastream, Australia, Canada, France, Germany, Italy, Japan, Sweden, Switzerland, UK, USA Emerging markets
Credit Suisse ** Emerging markets:
Brazil, China, India, Indonesia, Mexico, Russia, South Africa, Turkey

Global economy World follows US Fed’s tightening path
Emerging markets take a different path

In emerging markets (EM) inflation may take a different
path than in advanced economies. After 2011, inflation in
EM diverged from the advanced economies as growth
remained robust in the former and weakened in the latter
At its September 2018 meeting, the Fed’s Federal Open
Market Committee removed the reference to its policy
being “accommodative.” While the Fed’s new chairman,
Jerome Powell, has eschewed precise estimates of
“neutral” interest rates, consensus estimates of neutral
Spotlight
following the Eurozone crisis. Inflation in EM then declined are typically near 3%. Hence many market participants
on the heels of lower oil prices and weakening growth in will probably consider US policy close to tight by the end
China. Looking ahead, headline inflation in EM may rise to
some extent due to higher energy prices and the broad
of 2019. The European Central Bank (ECB), however,
is set to end net asset purchases at the end of 2018 and Proclaiming the demise of globalization
weakening of EM currencies in 2018. Yet we believe it is
likely that monetary authorities in most EM countries will
unlikely to hike rates before H2 2019. Thus, its policy
will remain accommodative. may be premature
focus on steadying currencies, helping inflation stabilize in
the course of 2019. In 2018, EM central banks have had to contend with tighter
Fed policy and an appreciating USD. The risk case for
Interest rates to rise them is that the USD experiences a further marked The intensifying trade conflicts of 2018 have raised the recessions, seemingly halting the globalization trend.
The base case of continued economic growth and moder- appreciation while global growth weakens. That would specter of a reversal of the post-World War II globaliza- Moreover, big declines in commodity demand and prices
ately rising inflation suggests that monetary policy will make things very difficult for policymakers. Even in the tion trend. We think this fear is exaggerated as most have the same impact. The effect is amplified as lower
tighten in most advanced and some emerging economies more benign case of solid global growth and no broad USD companies and countries continue to have a strong commodity prices reduce demand for mining-related
in 2019. At the time of writing, the futures market implied uptrend, EM central bank rates will tend to rise rather than interest in maintaining (more or less) open markets. capital goods. Finally, trade also tends to slow in
that the Fed funds rate would end up below 3% by the end fall given rising rates in advanced economies. However, we Moreover, we believe the US tariffs introduced in 2018 periods of USD weakness, mainly because US import
of 2019. This would imply one to two further rate hikes in still expect most central bank rates globally to end 2019 have so far been too limited to have a large effect. demand suffers; past instances of the USA imposing
2019, after a likely hike in December 2018, taking the real well below the peaks of the previous cycle. This is consis- tariffs (President Nixon in 1971, President Bush in 2002)
Fed funds rate to about 1%, broadly in line with our tent with the fact that this cycle is not driven by a significant That being said, our simple measure of globalization coincided with periods of weak growth or a weak USD.
forecast. credit boom, featuring extensive economic overheating. (global exports as a percentage of global GDP) has
stalled since the 2008 financial crisis but for largely Globalization unlikely to return to steep uptrend
cyclical reasons: trade growth typically falls during In line with this analysis, our globalization measure
has begun to recover with better post-2016 growth in
Significant central bank tightening since early 2018 China, as well as the 2018 recovery in oil prices and
Number of central bank interest rate increases vs. cuts globally in prior six months (net percentage) the USD. However, we believe it is unlikely that the
measure will revert to its steep upward trend anytime
Slowing trade penetration largely cyclical soon. First, growth in China and other emerging
80 Total global exports in % of global GDP markets that are strongly exposed to trade may be
slower for longer. Moreover, the non-tariff barriers many
60 countries introduced after the financial crisis may have
35 lasting negative effects on trade. Third, the growing
web of bilateral trade treaties may have simply diverted,
40
30 rather than boosted, trade. Finally, the globalization of
supply chains may have at least temporarily stalled as
20
25 wage costs rose faster in some EM to which production
had been outsourced. As trade barriers increase, the
0 incentive to move production to the countries imposing
20
barriers may further fuel that trend.
-20
15
-40
10
-60
5
-80
1964 1970 1976 1982 1988 1994 2000 2006 2012 2018
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Last data point 2017 US recessions and
2018 Credit Suisse estimate, China slowdown
Netherlands Bureau for Economic (2015/16)
Last data point October 2018 Policy Analysis estimate
Source Thomson Reuters Datastream, Credit Suisse Source World Bank, Credit Suisse

Global economy The global economy’s stress test
The global economy’s Corporates have significantly

lengthened the maturity of their
stress test borrowing so that the pass-
through from rising interest rates
to interest costs will be much
Economic downturns or financial crises typically occur slower than in past cycles.
when an economy exhibits significant imbalances.
Compared to 2007, household imbalances are markedly
lower in the USA but fiscal imbalances are greater. In the
Eurozone, both the external and fiscal balances have
improved. In emerging markets (EM), the picture is mixed.
Our base case for the global economy is moderately ƏƏ he US labor market, as measured by the unemploy-
T
optimistic despite some risks, as we described earlier. ment gap, looks slightly tighter than in 2007. Yet inflation
Nevertheless, key countries do have potential vulnerabilities pressures are lower, suggesting less need for outright
compared with previous pre-recession or pre-crisis years. tight monetary policy. This distinction is important because
phases of overtightening have tended to act as catalysts
US households in better shape for later recessions (e.g. in 1991).
The chart (see page 28) presents a spider web for a ƏƏ S households are in much better shape than in 2007.
U
relatively broad range of US economic and financial
While higher interest rates will gradually boost debt
indicators that allow for a differentiated risk assessment.
service payments, the risk to the economy appears
Comparing the current period with past pre-recession
limited. This is also due to less stretched real estate
situations yields the following results:
valuations, which suggests that the housing market is far
less likely to trigger a downturn.
ƏƏ orporate balance sheets are more exposed, however.
C
So long as interest rates are fairly low and growth is
robust, it should be unproblematic for corporates to find
funding. A sharper hike in rates and/or an economic
slowdown would be more worrisome, however. But bond
spreads appear to already discount higher corporate
risks. Moreover, corporates have significantly lengthened
the maturity of their borrowing so that the pass-through
from rising interest rates to interest costs will be much
slower than in past cycles.

Similar to the USA,

ƏƏ he external imbalance (i.e. current account relative to
T At current moderate interest rate levels, financing the debt is Eurozone juggles high debt, low growth
GDP) is more benign than in past pre-recession periods. fairly unproblematic. A significant rise in rates would make In the Eurozone, the key vulnerabilities – i.e. the fiscal
the UK also
But it has been worsening since 2013 and is projected matters worse, however, and could push interest costs as a balance and member countries’ external balance – have
to further deteriorate. share of GDP up sharply. An outright default of the US improved substantially compared to 2007 (see chart
ƏƏ he fiscal imbalance is higher than in past pre-reces-
T
sion periods. Prior to the 2001 recession, the federal
government is nevertheless very improbable given the Fed’s
potential role as lender of last resort. But in an economy
below). The key issue for the Eurozone is high government
debt, especially in Italy, coupled with low economic growth. continues to exhibit
budget reached a surplus of more than 2.5% of GDP;
in mid-2007 the deficit was just above 1% of GDP.
operating at full capacity, easier Fed policy could increase
inflation risks. Conversely, while tax increases or spending
Moreover, given that the ECB is winding down its asset
purchases (i.e. quantitative easing), pressures on public a twin deficit.
cuts might help fiscal dynamics, they would create head- sector debt may increase. Considering the huge size of
Despite nearly 10 years of expansion, the deficit is
winds to growth. Still, our view is that fiscal profligacy is Italian debt (approximately EUR 2.3 trillion, or 130% of
currently at about 4% of GDP and likely to deteriorate
unlikely to be a major issue for financial markets in 2019. GDP), any sign that the government is indeed moving away Emerging markets: The strong outnumber the fragile
further due to the 2018 tax cuts.
from fiscal discipline could have highly destabilizing effects The fragilities in EM as a group are fairly limited, in our
ƏƏ ublic sector debt has been rising and is above 100%
P beyond Italy, not least because the Italian banking sector view. However, the reliance on foreign savings was signifi-
of GDP (large unfunded public sector liabilities are not remains quite exposed to government debt. cant in selected countries, notably Argentina, Turkey and
included here). South Africa, and should have been seen as a warning
While the fundamental risk of instability has diminished in sign. Yet the external imbalances are less serious in other
the Eurozone, the picture for the UK is less clear. Similar to key countries such as Brazil, Mexico or Indonesia. Com-
the USA, the UK also continues to exhibit a twin deficit. In pared to the 1990s, the situation has in fact improved
its case, the external balance is more prominent than the dramatically. Countries that witnessed a major crisis at that
fiscal deficit. It seems unlikely that this situation will evolve time, notably Thailand and Malaysia, have significantly
into a financial crisis given the Bank of England’s credibility, improved their current accounts. But fiscal discipline has
but in case of continued uncertainty over relations with the deteriorated to some extent in most countries.
EU, questions regarding the funding of the external
imbalance may arise.
US vulnerabilities mostly lower than in 2007 Twin deficits have improved in almost all Eurozone countries
Selected measures of economic and financial vulnerability prior to past recessions and today (z-scores*) Fiscal and current account balances (in % of GDP)
Fiscal balance Current account balance
Greece
Current Portugal
Unemployment gap, inverse**
2007 Italy
2 2001
France
Housing market P/E Inflation gap*** 1990
Austria
* The z-score (or standard score) offers a Germany

0 standardized measure to compare
indicators. It measures an indicator’s Belgium
deviation from its long-term average at Netherlands
-1
any point in time.
Current account ** The unemployment gap is the difference Cyprus
BBB credit spread -2 deficit, % of GDP between the current unemployment rate
and its long-term average. Ireland
*** The inflation gap is the difference Spain
between the current inflation rate and the
US Federal Reserve’s 2% inflation Finland
target.
Non-financial corporate Federal budget United Kingdom

debt, % of GDP deficit, % of GDP Switzerland
Last data point Q2 2018

-8 -6 -4 -2 0 2 4 6 -15 -12 -9 -6 -3 0 3 6 9 12 15
Household debt, % of GDP Source Haver Analytics,
Bloomberg, Credit Suisse
Last data point 2017

2018 International Monetary Fund estimate
2017 – 2018 2006 – 2007
Source International Monetary Fund, Credit Suisse

The trade dispute with the USA or

China curbs appetite for debt Crisis risks are still rare
China is in a special fiscal situation: central government In conclusion, we believe that the potential for financial
other potential shocks pose a dilemma

debt is not very high, but debt of state-owned enterprises instability is lower in most countries and sectors than before
and local governments has increased sharply since the the 2008 financial crisis. The exceptions are select EM
for China’s policymakers, as they

financial crisis. Household sector debt is also elevated com- where the corporate sector is more vulnerable due to fairly
pared to household incomes. As most of China’s debt is high levels of foreign currency debt. In the case of China
may need to provide renewed stimulus

denominated in domestic currency and debts of strategic and the USA, where corporate debt is also high, the
sectors are backed by the central government, we see the exposure is largely in domestic currency and thus less risky.
to prevent a sharper growth slowdown.

risk of a financial crisis as quite limited. Moreover, efforts to In the Eurozone, we note a significant improvement in the
reduce that debt have been underway for some time. China financial stability metrics, but continued political risks.
But a crisis seems unlikely.

is also attempting to curb lending outside of its banking Similarly, the trade conflicts are essentially political, and our
system. In general, changing financial policy and concerns base case is that the key actors will not commit serious
about over-indebtedness are acting as a brake on Chinese judgement errors that would trigger significant turbulence.
growth, a pattern that is set to continue. The trade dispute Finally, we flag the rise of US public sector debt as a key
with the USA or other potential shocks pose a dilemma for long-term issue. The risk is not a debt default but a decline
China’s policymakers, as they may need to provide renewed in growth once the fiscal stimulus runs out. This could
stimulus to prevent a sharper growth slowdown. But a crisis exacerbate political tensions over how to rein in debt. One
seems unlikely. option, albeit not likely, would be more deliberate pressure
on the Fed to inflate away the debt, with potentially serious
consequences for the stability of the Treasury market and
the USD.
Lower financial vulnerability of emerging markets than in 1990s Forecasts for growth and inflation
Current account balance (as a % of GDP)
Real GDP (y/y %) Inflation (annual avg. y/y %)
Greater vulnerability Lower vulnerability 2017 2018E* 2019F** 2017 2018E* 2019F**
2017 – 2018
2006 – 2007 Global 3.3 3.3 3.0 2.4 2.8 2.8
Argentina 1990s pre-crisis USA 2.2 2.9 2.7 2.1 2.5 2.1
Canada 3.0 2.3 2.1 1.6 2.2 2.2

Brazil
Eurozone 2.5 2.0 1.8 1.5 1.8 1.8
India Germany 2.5 1.8 2.0 1.7 1.9 2.1
Italy 1.6 1.0 0.9 1.3 1.3 1.4

Indonesia
France 2.3 1.6 1.6 1.2 2.2 1.6
United Kingdom 1.7 1.2 1.5 2.7 2.5 2.2

South Korea
Switzerland 1.6 2.7 1.7 0.5 1.0 0.7
Malaysia Japan 1.7 1.3 1.0 0.5 0.8 0.8
Australia 2.2 3.2 2.8 2.0 2.2 2.3

Mexico
China 6.9 6.6 6.2 1.5 2.1 2.0
Russia India (fiscal year) 6.7 7.4 7.2 3.6 4.5 4.5
Brazil 1.0 1.8 2.3 3.5 3.7 4.3

South Africa
Russia 1.5 1.6 1.4 3.7 2.9 4.9
Thailand Last data point 08 November 2018

Source Thomson Reuters Datastream, Haver Analytics, Credit Suisse
Last data point 2017
Turkey 2018 International Monetary Fund estimate
Source International Monetary Fund, Note: Historical and/or projected performance indications and financial market scenarios are not reliable * E: estimate
-10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 Credit Suisse indicators of current or future performance. ** F: forecast

Global Economy Regions in focus
Regions in focus
Eastern Europe and Russia
United Kingdom Growth in Russia is likely to remain subdued
We foresee somewhat stronger but still even though higher energy prices support Japan
subdued growth. Uncertainty over the exports. Currency and bond risks are limited Japan is likely to enjoy robust growth in
outcome of the Brexit process is likely to due to a strong external balance and 2019, as corporate investment continues to
limit investment spending so long as the credible economic policy. Meanwhile, expand. Rising wages should support
outlook for supply chains, e.g. in auto growth in Central and Eastern Europe is consumer spending, but the sales tax hike
production and the financial industry, are likely to remain strong due to close planned for late 2019 poses downside
not clarified. A soft Brexit would support economic ties with Western Europe. risks. Exports may be negatively affected by
the GBP. The Bank of England is likely slower growth in China. The Bank of Japan
The ties that bind: Regional performance

to remain on hold. may nudge its bond yield target up slightly,
but is likely to continue to tread softly.
in an interconnected world
Eurozone China
With monetary policy still supportive and China’s growth is likely to weaken
employment rising, domestic demand somewhat in 2019. High real estate-related
should continue to expand. Strong US debt and debt service are likely to constrain
growth and stabilization in China as well consumer spending while the growth of
as emerging markets (EM) should support investment spending is likely to remain
exports. With the European Central Bank subdued. The government will probably do
only likely to begin raising rates in H2 just enough in terms of credit stimulus and
2019, EUR appreciation should be RMB depreciation to protect the economy
moderate at best. Tail risks include a hard from the impact of US tariffs.
Brexit and a debt crisis in Italy.
North America
One of the major risks to the region has
subsided after the USA, Mexico and
Canada agreed upon NAFTA treaty
revisions. US growth should remain above
trend in 2019 despite fading fiscal impulses
and inflation should rise moderately. The US
Federal Reserve is thus likely to continue to
raise rates at a steady pace. Canada and Australia
Mexico should benefit from strong US The economic outlook for Australia remains
growth. In the long term, the large US Middle East robust. Elevated prices for iron ore and
budget deficit could pose a risk if its The currency crisis of 2018 sharply energy should bolster exports, though
trajectory becomes unsustainable. raised inflation and undermined business China’s expected growth slowdown poses a
confidence in Turkey. However, a risk. Strong business confidence suggests
Africa recovery should begin in the course of that capex is likely to remain strong,
Growth in South Africa is likely to 2019 in response to stabilization however. Rising employment should support
pick up slightly in 2019 on the measures. Higher prices support Middle consumer spending, but higher interest
back of higher commodity prices, Eastern oil exporters, but Iran is in rates suggest that the real estate sector
but persistent failure to implement economic crisis, in part because of may cool off.
reforms may continue to hamper renewed sanctions. Growth in Israel is
the country’s performance. The likely to remain strong.
same goes for the continent’s
largest economy – Nigeria.
South America Meanwhile, reforms implemented
The region’s two largest economies – Brazil under the 2016 IMF program
continue to bear fruit in Egypt, with
and Argentina – are likely to remain weak in
strong growth and declining
2019, but hopefully the latter should begin to
inflation projected for 2019.
tackle some of its deep-seated economic and
fiscal weaknesses now that it is under an
Emerging Asia (ex-China)
International Monetary Fund (IMF) program. Switzerland India Growth in South Korea, Taiwan and Hong
With the pre-election deadlock over, chances The Swiss economy should benefit from While India is likely to remain the world’s Kong is likely to slow slightly amid the
are improving that Brazil may address some continued healthy growth among its main fastest growing large economy in 2019, the growth slowdown in mainland China and,
of its similar issues. In Colombia, Chile and trading partners. With the Swiss National tightening of global financial conditions in more specifically, in technology exports. In
Peru, the economic outlook continues to Bank likely to remain on hold until the ECB 2018 does pose downside risks. With the Southeast Asia, growth is likely to remain
brighten, and they should benefit from higher starts to raise rates, CHF strength should current account deficit widening, in part due significantly higher on the back of solid
commodity prices. abate. Meanwhile, domestic demand growth to higher oil prices, along with the INR’s investment and consumption. However, for
is likely to subside as immigration stabilizes depreciation against the USD since January economies with weaker external balances
at a lower level, while increasing overcapacity 2018, the central bank may need to tighten (Indonesia, Philippines), policy tightening to
in rental units slows construction. monetary policy more meaningfully. stabilize the currency poses downside risks.

Special Supertrends Special Smart sustainable investing
Supertrends: Why sustainable

Investing in change investing is smart
In May 2017, we took a fresh approach to equity investing, Sustainable and impact investments have seen remarkable
launching our five Supertrends. These long-term investment growth. The urgent need to unlock the positive power of
themes seem to have struck a chord with investors, adding capital for change is best captured by the United Nations
positive value since inception. Sustainable Development Goals (SDGs). Making these
objectives investable is a key trend in sustainable and
impact investing.
Unsettled by financial market disruptions, investors today To date, Supertrends stocks or products are added to
are looking for fresh approaches to investing. These portfolios mainly to complement existing equity holdings.
include evolving areas such as impact investing, as well as But as time passes and presuming the Supertrends
new approaches to traditional asset classes. In May 2017, continue to deliver the results we expect, we anticipate
we launched our five Supertrends as an alternative way to that investors may increasingly devote a larger share of Sustainable finance and impact investing have experienced Impact finance and investments make the difference
invest in global equities. At the time, investors were already their equity portfolios to these themes, turning them into remarkable growth in recent years. Institutional investors in Measurable impact investment goes a step further and is
confronted with an increasingly complicated global equity mainstream holdings. particular have driven global demand for sustainable key to addressing the large funding gap that is required to
investing environment with demanding valuations in certain investments, a market that reached USD 23 trillion in achieve the UN’s 17 SDGs. Among these goals, higher
markets and large differences in terms of performance Eye on sustainability and impact 2016, according to the Global Sustainable Investment education stands out as an investment that has a deep
across sectors and regions. Our view was that the success- Similarly, we find that investors increasingly seek to construct Alliance. There has also been a notable increase in interest impact because it creates a stable middle class that can
ful passive equity investment trend of the quantitative easing portfolios that meet environmental, social and governance and demand from other key client segments that we serve, support and develop the broader economy and society. In
era, such as exchange-traded funds (ETFs) on global equity (ESG) criteria. An increasing number of investors go even including foundations and private wealth clients, with an developing markets, enrolment in primary education has
indices, would no longer deliver the same performance going further and invest with a view to making a specific social exceptionally strong push from the mission-driven next reached 91%, according to the UN. However, many young
forward. or environmental impact. One of our Supertrends – “Mil- generation, which we focus on as part of our Supertrends. people are unable to continue their studies in secondary
lennials’ values” – already reflects this increasingly important schools and even fewer at universities given the limited
Differentiated approach investment trend: it only retains stocks that fulfill minimum The top investment objectives identified by sustainable and means of many families and financing challenges faced by
We developed the Supertrends with a view to investing ESG criteria. impact investors are to achieve attractive returns comple- governments.
globally in listed equities, but along very clear high convic- mented by risk mitigation and portfolio diversification, and
tion themes. These are based on multi-year societal trends New impact investing solutions address two of the key of course to make a difference in the world. The creation of innovative structures in impact finance
that we believe will likely drive economic policy, company issues of our time: healthcare and education. These makes it possible to invest in higher education projects that
results and stock performances in a meaningful way for solutions help provide a link between capital needs (for A careful approach to stock selection yield market returns for investors. Students have access to
years to come. They cover themes ranging from population example students who seek a university education) When it comes to sustainable investments based on funding at moderate rates, allowing them to attend a quality
aging and the Millennials, to technological progress, the rise and investor needs in these areas. The following pages environmental, social and governance (ESG) factors, university. The quality of such loans is high: these students
of a multipolar world and the upgrade of infrastructure provide more information about some of the exciting companies are screened to exclude entities that are typically have a repayment ratio that is well above average.
worldwide. avenues Credit Suisse is pursuing as we bring impact controversial or in breach of basic norms, and to promote And the investment in securitized bonds is diversified as
investing into the mainstream. sustainable investment by selecting entities with a best-in- there are hundreds of underlying quality loans to talented
Within the technology theme, our investments in areas like class approach. Increasingly, quality data points are students with a low correlation to capital markets.
artificial intelligence, virtual reality and healthtech, all of which emerging to support these investment goals, including
have recorded double-digit returns in the past one-and-a half strong correlations between high ESG scores and financial Smart investing
years, have proven to be the strongest. Infrastructure was performance, using ESG factors as a predictor of future At Credit Suisse, we look back on 15 years of successful
the slowest performer, however, but should benefit from earnings volatility, and as a defensive haven during market impact investing in the areas of education, financial
renewed catalysts in 2019 as economic policy focuses on corrections. inclusion, climate change, gender-lens investing and
infrastructure expenditure again. affordable housing. Based on this experience, we can say
confidently that investing in companies and opportunities
that are sustainable and impactful is simply smart investing.

Special Impact investing
Pay it forward – At Credit Suisse,

Impact investing we b elieve in
the multiplier effect
and education of investing in
Impact investing has experienced explosive growth as people
education.
seek investments which generate a financial return while
creating a measurable positive social and e nvironmental
impact. This area is being aligned with the UN’s 17 SDGs,
which include gender equality, clean water, zero hunger and
quality primary, secondary and tertiary education.
What motivates someone to invest in education? Why does Credit Suisse believe education is an
For students in low-income countries, the hurdles to How great is the need for private initiatives One of the biggest motivators I see for our private clients is attractive investment area?
higher education can appear insurmountable. While 91% in education? that they benefitted from access to a quality education At Credit Suisse, we believe in the multiplier effect of
of children in developing countries are enrolled in primary It is absolutely critical that the private sector step in. In themselves. This is particularly true for clients who come investing in education. The recent Goalkeepers Report*
school, just 1 in 12 young people will obtain secondary a 2015 report, UNESCO estimated that the annual from developing countries where universal education is a from the Gates Foundation highlighted the importance of
level skills in the least developed countries, according to funding gap for education would be at least USD 39 billion privilege, not a right. They often feel that education was investing in young people and especially in their educa-
UNESCO data. between 2015 and 2030. UNESCO is calling for more and their lottery ticket to a fortunate life and they want to pay it tion and health in order to create opportunities. If an
better financing to achieve the ambitious SDG goal: a forward. individual’s investment in education can help reduce
Many young people are unable to continue their studies in quality education, for all levels of education, in all countries, mortality, increase peace and security, stem the effects
secondary schools and higher education given the limited regardless of gender. What are the financial returns vs. risks in this space? of climate change, lift people out of extreme poverty and
financial means of their parents and financing challenges A key tenet of impact investing – and this is very important foster economic prosperity – all while generating a
faced by governments. In addition, donations devoted to How developed is the overall impact investing market for investors – is that the investment must come with a financial return – we think the attractiveness of the
higher education represent just a fraction of global for education? commitment to measure the impact. There are two kinds investment case speaks for itself.
donations. The average person in Sierra Leone would Today the impact investing market for education is relatively of strategies: impact investors can seek to achieve returns
have to work more than 100 years to pay for one year at nascent compared to other SDGs like clean energy. consistent with traditional returns for a given asset class;
Harvard. Historically, education funding has largely rested within or they can generate concessionary returns with a portion of
philanthropic circles and the non-profit sector. The the return coming in the form of the impact the investment
In an interview, Marisa Drew, Chief Executive Officer of 2018 Global Impact Investing Network (GIIN) survey is making. The risks are the same as for traditional
Credit Suisse’s recently established Impact Advisory & showed that only 4% of total impact investing assets under asset classes, although most impact investments tend to
Finance Department (IAF), discusses how investors can management (AuM) are dedicated to education. However, be in private markets where duration is longer and liquidity
make a positive change in education. there is increasing awareness within the private sector that is more limited.
enormous funding gaps exist. According to GIIN, 20% of
impact investors surveyed deployed capital in education in
2017 and 36% planned to increase their allocations to
education in 2018. * gatesfoundation.org/goalkeepers/report

Financial
markets
In short
Anticipating asset trends
US financial markets entered a late stage of the economic cycle in 2018, characterized by rising interest
rates combined with a flattening yield curve. Our base case for 2019 foresees only a moderate further
increase in US yields. This suggests that US fixed income investors should prepare to lengthen
duration. In core bond markets outside the USA where yields are far lower, duration should remain
short. In credit, the risk-return trade-off looks better for high yield than for investment grade bonds.
Equities should continue to outperform on the back of robust earnings growth. Emerging market (EM)
assets, which came under pressure due to tighter US monetary conditions, should regain ground as
long as the risk of US rate hikes and USD strength abates.
Pockets of growth in certain sectors

Despite some wobbles, technology stocks continued to outperform in 2018. We expect economic
growth to normalize in 2019. But in line with late cycle patterns, growth stocks should generally
continue to outperform. This should include the healthcare sector, especially if companies achieve
breakthroughs in areas such as gene therapy. Some cyclical sectors like capex-oriented industrials
should be buoyed as well. In Europe, depressed financial stocks should benefit from rising yields, while
in the USA, the flattening yield curve will likely weigh on the sector. Real estate stocks may also
remain under pressure due to rising interest rates.
Where to for currencies?

In 2018, the USD made moderate gains against the other major currencies, but appreciated significantly
against a number of EM currencies. Going into 2019, we have a neutral view on EUR/USD. While
the yield gap continues to support the USD, the start of monetary policy tightening outside the USA is
likely to work against the currency. Valuation continues to speak in favor of the GBP as well as a
number of EM currencies, some of which are also supported by a greater carry advantage. Among
safe havens, we favor the undervalued JPY over the more expensive CHF.
Financial markets Positioning for late cycle growth
Positioning for The US economic Financial market forecasts / performance 2019
cycle still matters 2018 YTD
late cycle growth most for global

performance on 2019 expected
Equities* 07 November 2018 total returns
financial markets.
US equities 6.78% 5.50%
EMU equities -4.21% 4.00%
Swiss equities 0.14% 4.80%
UK equities -4.04% 5.00%
Japanese equities -6.31% 1.50%
As the US transitions from economic recovery and expansion to Emerging market equities -7.04% 8.30%
overheating, the return profile for a number of asset markets is Close on End-2019
likely to change, with key implications for investment strategy.

Bond yields 07 November 2018 forecast
10-year US Treasury yield 3.24% 3.30%
We continue to believe that equities should outperform. 10-year German Bund yield 0.45% 1.00%
10-year Swiss Eidgenossen yield 0.02% 0.50%
2018 YTD
performance on 2019 expected
Credit 07 November 2018 total returns
Global investment grade bonds** -1.82% -1.00%
Global high yield bonds** 1.09% 3.00%
Emerging market HC bonds*** -4.59% 5.00%
Currencies Close on End-2019

& commodities 07 November 2018 forecast
Unexpected political developments had a considerable
EUR/USD 1.14 1.20
impact on financial markets in 2018, and are bound to
USD/CHF 1.00 1.00
move them in 2019 as well. Nevertheless, the economic
EUR/CHF 1.15 1.20
cycle will remain the key driver of markets. The behavior of
USD/JPY 113.53 105.00
the major asset classes tends to differ considerably
depending on the stage of the economic cycle. We have GBP/USD 1.31 1.40
taken these factors into consideration in developing our USD/CNY 6.93 7.20
base and risk scenarios for the main asset classes in 2019 Gold (USD/oz) 1228.51 1250.00
and determining our investment strategy. WTI (USD/bbl) 61.89 67.00
Why the US cycle matters most

The US economic cycle still matters most for global
financial markets. While the US economy now represents * Performance and expected returns are total return including dividends. Markets
refer to MSCI country / regional indices in local currency. Performance of the
slightly more than 20% of the world economy (and less periods 07/11/2013 – 07/11/2018 for those indices in chronological order are:
than 15% adjusted for differences in purchasing power), MSCI USA: 18.5%, 5.4%, 3.5%, 24%, 10.6%. MSCI EMU: 3.8%, 19.7%,
the US equity market still constitutes 54% of the global -7.1%, 26.5%, -6.8%. MSCI Switzerland: 10.3%, 5.2%, -8.9%, 23.4%, 1.6%.
MSCI UK: 1.5%, -0.5%, 11.4%, 14.6%, -1.3%. MSCI Japan: 17.6%, 15.3%,
equity market (MSCI AC World). And while the US high -12.3%, 34.7%, -6.4%. MSCI EM: 5.9%, -0.8%, 6%, 29.2%, -6.7%
grade bond market, at 41%, represents a smaller share of ** Barclays Global Investment Grade Corporate and Global High Yield index
the global bond market, US bond yields are a key driver of *** JP Morgan EMBIG Div. (sovereign index)
global asset markets, as the USD remains the largely

Source Thomson Reuters Datastream, Credit Suisse
undisputed global reserve currency. Hence, although the
Last data point 07 November 2018
decisions of the US Federal Reserve (Fed) are largely
driven by domestic considerations, its policies determine Note: Historical and/or projected performance indications
the price for the bulk of global liquidity. In addition, most and financial market scenarios are not reliable indicators
global fixed income assets are priced based on the US of current or future performance.
Treasury curve. Given the strong influence of the US
economic and rate cycle on global markets, we therefore
focus on the base and risk scenarios for US interest rates
as we look ahead to 2019.

US economy remains on track

Our base case for the US economy in 2019 suggests that
curve would shift upwards. Conversely, if the economy were
to slow sooner, the yield curve would invert. The key As long as the risk
of US rate hikes and
the combination of further Fed policy tightening and the implication of an expected flattening of the US yield curve
fading fiscal impulse should dampen any economic over- is that USD-based investors should prepare to extend
heating, and that some signs of a slowdown are likely to duration in 2019. Meanwhile, adding inflation-protected
USD strength abates,

emerge. The main risk case would be continued strong bonds to the portfolio would provide protection against
growth and overheating. The risk of an outright contraction, a possible protracted phase of overheating.
in contrast, seems quite limited, at least in 2019.
EM equities should
As long as the global economy avoids a contraction in
The main implication of our base case is a further flattening 2019, as we assume, our analysis suggests that credit
of the US yield curve. In the risk case of prolonged over- should outperform Treasuries. The greater the confidence
benefit.
heating, longer-dated yields would rise further and the in the base case, or even an overheating scenario, the
Asset class performance patterns across the business cycle
Highest returns for Highest returns for bond-proxy Highest returns for gold Highest returns for
most risky assets equities and long-duration bonds and high-yield credits real estate
Oil
Real estate
++
Equities
Information technology
Momentum
larger the warranted allocation to higher-risk bonds. Yet it EM local currency bonds is China: should the RMB
Momentum
Staples
Energy equities
Healthcare
HY credit
is important to assess whether valuations support such depreciate further, other EM currencies might come under
exposure. At the time of writing, US high yield spreads renewed pressure.
Gold
HY credit
Govt. lg**
IG credit
Small cap
Staples
were above 350 basis points. This seemed to provide a

reasonable buffer for a robust economic scenario, but little Finally, bonds in other hard currency regions such as
USD
+
leeway for any significant negative surprises and higher Japan, the Eurozone and Switzerland are less affected
Govt. st*
default rates. US high yield also remains exposed to by the US economic and interest rate cycle. Domestic
Equities
idiosyncratic risks, especially energy prices. economic developments and monetary policy are more
important. In our base case, economic growth should
US investment grade bonds seem less attractive, however. remain robust in these regions and monetary policy should
USD
Although cash positions of US corporations remain quite begin to normalize. As yields in most markets remain
–
Utilities
high, leverage has increased substantially since 2014 due extremely low, returns are likely to be weak or even
Telco
USD
to stock buybacks and higher investment spending. negative in 2019. A short duration stance therefore remains
Moreover, spreads are tight by historical standards and the warranted in these markets. In credit, senior loans still
benchmark duration is long as corporations have until seem attractive in Europe as bank asset quality should
recently taken advantage of the low yield environment to continue to improve. However, a specific tail risk for
Oil/Commodities
issue longer-dated bonds. Hence this sub-asset class will European credit is a loss of fiscal discipline in Italy and
– – tend to underperform Treasuries in both risk cases. A mix rising concerns regarding a possible Italian exit from
between Treasuries and high yield seems a better choice. the EUR.
Brighter outlook for emerging market bonds Equities still offer potential
Overheating Slowdown Contraction Recovery
As for the non-USD bond segment, emerging markets In a late cycle phase, equities typically continue to outper-
(EM) are likely to be most affected by US interest rate form most asset classes. Thus, equities should still be
developments. Indeed, 2018 provided a stark reminder favored unless valuations become too stretched or a
that tighter USD liquidity can put severe strain on EM contraction takes shape. That being said, the performance
* Short duration government bonds Note The chart shows the typical asset class performance patterns across the following four US economic cycle phases, or
** Long duration government bonds regimes (sample: 1990 – 08/2018): assets. Yet if our base case materializes and pressure on of different sectors may diverge substantially depending on
1 “Overheating” phases are characterized by economic growth remaining above trend and inflation rising. the Fed to tighten policy eases, EM hard currency bonds their sensitivity to interest rates. As for investment styles,
2 “Slowdown” phases typically follow efforts of policymakers to halt overheating. should outperform. Insofar as a less aggressive Fed momentum stocks tend to do well late in the cycle. This
3 If these policies have been too harsh or other negative shocks occur, an outright “contraction” or recession phase may ensue.
4 “Recovery” phases are the periods following the low point of the cycle, i.e. the trough of recessions, and typically include a fairly reduces pressure on EM currencies, EM local currency should benefit large leading sectors such as IT, one of our
Source Credit Suisse, Bloomberg prolonged economic expansion. bonds should also do well. One of the key risks for preferred sectors at the time of writing.

Similar to bonds, EM equities tend to be significantly

affected by the US economic and interest rate cycle. As
long as the risk of US rate hikes and USD strength abates,
EM equities should benefit. That said, the influence of
Asian growth is stronger for EM equities than for EM bonds
As we look to 2019,
our base scenario
suggests that
Spotlight
due to the large weight of Chinese and other Asian equities
in the MSCI EM index. Indeed, the Chinese domestic equities should
market is so large that its own business cycle has a major
impact on EM equities. Our base scenario for China is a remain at US yield curve inversion:
further moderate slowdown in growth, accompanied by
somewhat easier monetary conditions, which would support overweight. Do we need to worry?
equities. While continued robust US growth would also
support Chinese and other EM equities, the risk of a further
escalation of the trade conflict with the USA warrants The US yield curve flattened significantly in the course monetary policy, which in turn implies that the central
some caution. USD under opposing influences of 2018, with shorter-term interest rates rising much bank has tightened policy too much, increasing reces-
It is challenging to predict the direction of the USD in 2019. more than longer-term yields. In the past, flat or inverted sion risk.
Most equity markets in advanced economies outside of the In past late cycle phases, especially when the US yield yield curves have coincided with recessions (see chart),
USA – with the exception of Canada – also depend less on curve inverted (i.e. markets considered monetary policy too which is why this development may raise doubts about “This time is different” – or maybe not
the US rate cycle and economy. In 2018, most developed tight), the USD would rally. Depreciation would then set in the current, rather optimistic, outlook for US growth. Some argue that there are structural reasons for the
market equity indexes lagged their US counterparts due to once the economy slowed and the Fed began to ease. We yield curve to be flatter than in the past. For instance,
the low weight of technology companies within their indices think it is unlikely that the Fed will tighten policy excessively Here is why a flatter yield curve tends to foreshadow they suggest that the term premium, i.e. the added
and as extremely low interest rates continued to hurt in 2019. Conversely, any slightly hawkish surprise from the an economic slowdown: central banks typically raise interest investors receive for holding longer-maturity
financial stocks. In Europe, political risks likely added to European Central Bank (ECB) or the Bank of Japan (BoJ) short-term interest rates to reduce inflation pressures bonds, should be smaller than in the past because
the underperformance. But the Eurozone market may well would tend to strengthen the EUR or JPY. At such that emerge during a strong economic expansion. This inflation risks are fundamentally lower because of
catch up, barring a renewed crisis triggered by Italy. In this a tipping point, the large US twin deficit might once again lowers the inflation expectations component in bond central banks’ apparent success in containing inflation,
context, steady economic growth and a meaningful come into play and put downside pressure on the USD. yields. However, the central bank’s action also raises which has helped to permanently lower inflation expec-
increase in interest rates would support financials and real yields. Higher borrowing costs subsequently slow tations. We have some doubts about this argument, not
other domestically focused Eurozone equities. Investment strategy for 2019 the economy. A yield curve inversion means that the least because the curve has been just as steep in this
As we look to 2019, our base scenario suggests that bond market has begun to discount a future easing of cycle as in past cycles and because US inflation
Chinese demand should support commodities equities should remain at overweight. However, US expectations are in fact back to average levels. More-
Most commodities, except for precious metals, tend to be investors should begin to lengthen bond duration. Valua- over, some factors, including much higher government
highly cyclical assets. In most cases, they continue to do tions for EM bonds and currencies seem fairly attractive debt, suggest the term premium should actually be
reasonably well in late cycle periods. But a significant rise in but China poses risks, and the same holds true for EM higher than in the past. Hence, we believe it is prema-
interest rates and a stronger USD tend to slow the ascent equities. In credit, high yield seems to offer a better Yield curve flattens ture to discard yield curve inversion as a warning sign of
of commodity prices. Given our fairly moderate scenario risk-return trade-off than investment grade bonds. Demand US Treasury yield spread: 10-year minus 2-year recession.
for interest rates and the USD, this factor should not play for commodities should remain robust, while the factors (in % points)
a dominant role in 2019. As long as China’s all-important supporting and weakening the USD are likely to be more That said, we do not actually expect the curve to invert
demand for commodities holds up, cyclical commodities or less in balance. 3 in 2019, not least because the Federal Reserve (Fed) is
should remain supported. itself likely to regard a flatter curve as a warning sign. If
the curve becomes too flat, the Fed will likely pause in
its tightening path and thus allow the curve to steepen
2
again in response to less restrictive policy.
1989 1993 1997 2001 2005 2009 2013 2017
US Treasury yield spread

Last data point 30 October 2018
Source Credit Suisse, Bloomberg US recessions

Financial markets The sector standpoint
The sector standpoint

Significant divergences characterized sector performance ticket items, such as autos are likely to remain under
in 2018. The two leading growth sectors – IT and healthcare pressure, while structural growth trends, such as the
– delivered the strongest performance. No clear trend pre- expanding middle class, should support luxury goods
vailed across cyclicals versus defensives. Energy was flat including cosmetics and high-end alcoholic beverages.
amid volatile oil prices, while tighter US monetary policy and Higher tariffs on China would primarily hurt US consumers.
the associated flattening of the US yield curve took a toll on Meanwhile, e-commerce is becoming the new normal and
financials. online sales are likely to continue to grow strongly. Some
The outlook for most sectors around the world depends incumbent retailers are successfully adapting in this area.
on global or regional business cycles. Where leverage is high, Looking to 2019, we believe that some of these trends
should continue. For instance, we believe that capital Energy: Focus shifts to long-term growth
interest rate movements will have a significant impact. expenditure during the late cycle may provide a boost for The outlook for the energy sector is positive as earnings
Moreover, rapid technological progress continues to boost the industrials sector, while innovation and more attractive
valuations could lift materials. The key question is whether
are likely to be boosted by rising production volumes and
higher prices. Valuations have returned to fair levels. As
innovators and disrupt many established companies. IT and healthcare will again generate strong returns. While momentum in oil prices and earnings per share (EPS)
growth in most IT sectors should ease, we believe that growth eventually eases, investor focus is likely to shift to
innovations continue to make the sector attractive. In longer-term growth. Investors will closely watch for possible
healthcare, we also see room for major advances, for production constraints in the Permian Basin in the USA and
example in the area of gene therapy. the shale industry, as well as the impact of such constraints
on exploration and oil services companies. Tightening
Consumer: E-commerce is the new normal regulation on shipping fuels for refineries is another area of
The consumer sector should benefit in our base scenario concern. Finally, investors will look out for signs of recovery
of continued robust growth and tight labor markets, though in offshore drilling after prolonged weakness in that area.
China and the trade dispute are key risks. In China, big
IT still in the lead Strong increase in biotech M&A activity

MSCI World total gross sector returns (in %)
2015 Q1
IT
Q2
Materials
Q3
Industrials Q4
World 2016 Q1
Cons. Discretionary Q2
Q3
Financials
Q4
Health Care
2017 Q1
Cons. Staples Q2
Real Estate Q3
Utility Q4
2018 Q1
Telecoms
Q2
Energy
Q3
-20 -10 0 10 20 30 40 0 10 20 30 40 50 60 70 80 90 100
2018 YTD 2017 annual Number of transactions Deal value (USD bn)
Last data point 08 November 2018 Last data point 10 October 2018
Source Bloomberg, Credit Suisse Source Bloomberg, Credit Suisse

Financial markets The sector standpoint
Financials: Structural challenges remain Materials: Shifting production and product trends Utilities: The evolution towards greener and cleaner Real estate: Looking for new opportunities
Growing demand for loans in most advanced economies In steel, we expect production to keep improving on the Rising interest rates could put further pressure on the amid headwinds
should prove beneficial for financial stocks. In Europe, a back of strong demand. Environmental concerns in China valuations of regulated utility companies, especially in The real estate sector is influenced by two opposing
further steepening of the yield curve in anticipation of the should boost demand for higher-quality iron ore to reduce Europe. Regulated utilities also have to digest new tariffs factors. Economic growth and rising yields (associated with
European Central Bank’s rate hikes should also be benefi- pollution. As China takes capacity out of the market and for regulated returns in Spain and the UK. In addition, growth). In that sense, 2018 was a difficult year for listed
cial, while further curve flattening in the USA could act as a shifts to higher-quality iron ore, the global supply for steel investors will focus on the ongoing shift towards renew- real estate as US interest rates moved up significantly.
drag. However, national regulations, weak balance sheets should remain balanced in 2019. In the chemicals sector, ables in electricity generation portfolios as costs are falling Looking ahead, 2019 is likely to bring more volatility.
and inadequate provisioning are slowing the much needed China is shifting from coal to gas as a raw material input. to competitive levels. Thermal power producers are Though economic growth remains supportive, a further
consolidation of the European banking sector. Cross-border Mining companies should continue to return capital to benefiting from nuclear power plant closures in Germany normalization in global monetary policy is a headwind. In
mergers and acquisitions (M&A) are more likely in insur- shareholders by paying attractive dividends and buying back and Belgium as well as expected coal plant closures across addition, pricing in commercial real estate markets looks
ance, with non-life and health the preferred targets. In shares. We see strong themes continuing in chemicals, several countries. Another area of focus is the recent spike increasingly stretched, especially in the USA. As the cycle
banks, the focus remains on cost containment rather than including the evolution of battery technology for electric in EU carbon prices. If this trend continues, it would support becomes more mature, investors have to be more selective
growth, though attractive potential dividend yields could vehicles and the migration from plastics to biodegradable another increase in power prices and generate windfall and look to opportunities beyond traditional core strategies.
provide a boost to the subsector. products. A potential slowdown in China is the key risk profits for clean electricity generators. One example is logistics real estate, which benefits from
for the sector given that market’s dominance. the continued expansion of e-commerce; or assisted living
Healthcare: Innovation and M&A driving growth and healthcare facilities to cater to the needs of an aging
We expect to see a wave of adoption of biosimilar medi- Telecom: Strength in mobile, weakness in fixed line population.
cines over the coming years, supported by more aggressive Differences between individual markets are likely to remain
leadership from the US Food and Drug Administration. significant in the telecom sector. In the USA, we expect
This should enable large companies to invest in significant wireless market trends to improve thanks to new 5G
innovations, including gene therapy. Some of these offerings. In Europe, the regulatory environment is im
therapies should become available in 2019 in the USA, proving. With a separation of network and services now
including treatments that could be close to a cure for spinal possible, shares of network companies may rerate.
muscular atrophy and hemophilia A. Fears of politically Attractive potential dividends and historically low relative
driven regulatory interventions are abating. We believe the valuations should attract investors, especially if growth
companies that should outperform are those that lead optimism diminishes. In Japan, competition is set to
innovation, whether developing new treatments inhouse or intensify as a fourth operator has entered the market. In
through tapping the small and mid-cap segment for M&A. China, consolidation is on the horizon because the invest- Carbon-free electricity generation supported by surging CO² prices
ments for 5G networks are too high for companies to CO² prices on the European Emissions Trading Scheme (EUR per ton)
Industrials: Set for late cycle growth finance on their own. Pressure from governments world-
Valuations of the industrials sector are at a cycle high, but wide to roll out 5G networks and initiatives in areas such as
30
growth in EPS and revenues should benefit if economic the Internet of Things could decide the sector’s fate.
growth remains robust, as we expect. The capital goods
subsector should be lifted by the recovery in the mining,
oil and gas and industrial construction industries. The sector 25
should also benefit from innovation in the automotive
sector and further investment in robotics across industries.
20
IT: Growth cools off
Earnings momentum in the semiconductor industry is likely
to ease after two-and-a-half years of strong growth. This is
15
mainly due to expanding manufacturing capacity, which
puts pressure on chip prices. That said, excess capacity is
limited and the correction should be fairly mild given strong
underlying demand for chips from data centers and sectors 10
such as communication. The internet and software indus-

tries should benefit as companies shift to areas such as
cloud infrastructure, business process digitalization and 5
hyper-scale data centers. The IT hardware sector might see
a slowdown in PC demand, with growth in the smartphone
market expected to decline to a low single-digit rate despite
innovations such as foldable screens, augmented reality 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
services and 5G networks.

Source Bloomberg, Credit Suisse

Financial markets The state of play for currencies
The state of play Currency markets provided a number of surprises in 2018. against the other major currencies. It is hard to tell whether
Forecasts generally assumed that the major currencies the twin deficit might re-emerge as a risk factor for the
would be able to build on their gains in 2017 against the USD. This would most likely happen if US economic growth
for currencies
USD. Yet the stronger-than-expected growth momentum in slowed markedly, a development we consider unlikely in 2019.
the USA prevented them from doing so. In response to
strong growth, the US Federal Reserve (Fed) continued to As for emerging market (EM) currencies, we sense a
raise rates while the central banks of other advanced bigger shift in fundamentals: policymakers in many EM
economies retained a dovish stance. The interest rate or were forced to raise interest rates as their currencies came
carry advantage (positive difference in interest rates under pressure in 2018. As a result, the carry between EM
between two currencies) for the USD thus increased. currencies and the USD has increased, in some cases
Furthermore, the worsening US twin deficit did not weaken substantially. At the same time, the valuations of a number
Investing in foreign currencies does not usually generate excess the USD. of currencies have become more attractive. This suggests
returns compared with holding domestic cash. When currencies Looking ahead to 2019, we believe that a further surge of
that both carry and valuation-based strategies may once
more be effective assuming fundamentals stay constructive.
are clearly undervalued, however, it can be worth taking such the USD is unlikely. While US growth is likely to remain Specifically, currencies will only appreciate if the external
positions. Conversely, holding low yielding s afe-haven currencies higher than in other advanced economies, the gap should
narrow. As for US central bank rates, they will remain sig-
balance of the respective country stabilizes. Progress on
rebalancing should therefore be watched carefully.
pays off when risks spike significantly. nificantly higher than in other advanced economies, with
the gap likely to even widen until mid-2019. If growth and Political twists in the road
inflation continue to pick up outside the US, non-US central In 2018, political events also impacted certain currencies.
banks may, however, start tightening sooner. Finally, our The escalating trade tensions between the USA and China
valuation screen shows a moderate USD overvaluation depressed the RMB, while the close economic links of
And the winner is… the USD

Spot and total returns of selected currencies vs. USD in 2018 (in %)
10
-10
-20
-30
-40
-50
MXN MYR THB JPY NOK PHP CNY TWD CAD GBP CHF KRW IDR EUR CZK AUD BRL PLN ZAR INR RUB HUF SEK TRY ARS
Total return
Spot return
Source Bloomberg, Credit Suisse
Note The chart shows exchange rate changes of a number of currencies versus the USD from the start of 2018 to the editorial deadline. It also shows the total returns from
taking a long forward position in each of these currencies versus the USD, i.e. the sum of the positive (or negative) interest rate differential (the so-called carry) and the
exchange rate change. The conclusion is that carry strategies generated negative returns, with losses most significant for the ARS and TRY. Next to the MXN, only one carry
currency generated positive returns: the USD.

Financial markets The state of play for currencies
Japan and China may have prevented the attractively valued

JPY from appreciating. In Europe, worries over Italian fiscal
policy temporarily boosted the CHF, while the GBP swung
back and forth with every twist in the road leading to Brexit.
Looking to 2019, we do not think that the US-China trade
SEK looked clearly attractive based on our valuation screen
as we went to press. Among EM currencies, the TRY and
MXN seemed attractive. The NZD and CHF appeared
expensive, while the only EM currency that looked expen-
sive was the THB.
Spotlight
conflict will be resolved quickly. As a result, the RMB may
remain under pressure. Insofar as the Chinese authorities In terms of carry, two EM currencies, the BRL and TRY,
continue to ease monetary policy, this trend is set to per-
sist. Yet we believe that China will proceed cautiously to
looked attractive. Overall, our expectation of a fairly benign
inflation picture in EM and a very wide real rate differential The twin deficit – boon
avoid triggering investor uncertainty and capital outflows. relative to developed markets, including the USD, suggests
that other EM currencies may also outperform the USD. or bane for the USD?
As regards the conflict over the budget deficit between Italy Meanwhile, some of the traditional advanced economy carry
and the European Union, we believe it is quite unlikely that currencies, in particular the AUD, have lost appeal in the
the European Central Bank will give in to Italian political wake of Fed tightening. Among the safe haven currencies, The so-called US twin deficit, i.e. the combination of Conversely, an increase in the current account deficit
pressure. Hence the EUR currency pairs should be little the valuation divergence between the somewhat overvalued a significant fiscal deficit and a current account deficit, may weaken the currency in some situations. This is
affected by these tensions. Meanwhile, valuation remains CHF and the undervalued JPY should close, especially if is often seen as a risk factor for the USD. Yet the because an increase in the current account deficit
highly supportive of the GBP, implying that a soft Brexit trade war concerns abate. evidence is mixed. During the economic boom under requires global investors to increase investments in the
may well help close the valuation discount. Conversely, a US President Reagan that started in 1982, a worsening respective currency. To entice them to do so, the
hard Brexit and its ensuing chaos would intensify pressure In conclusion, investors who hold large amounts of cash in twin deficit coincided with a substantial strengthening of compensating risk premium on the currency must rise.
on the GBP. low-yielding currencies (i.e. the CHF and EUR) that trade the USD. In all other instances, the USD weakened. To achieve a higher risk premium, yield spreads have to
within their fair value band should be able to enhance This ambiguity results from the fact that rising fiscal increase or the currency has to get cheaper, or both.
EM currencies look more attractive returns by taking positions in some of the value or carry deficits, often the main driver of a deteriorating external
The developments of the past year appear to have pro- currencies described above. For USD-based investors, balance, boost growth and real interest rates. The latter It is hard to tell whether higher real interest rates or a
duced a situation in which value and carry overlap for a there is less incentive to take such positions as US cash are generally considered to bolster a currency. If a higher risk premium will dominate in 2019. So long as
number of currencies. Investors may thus be able to returns are higher. That said, with the USD somewhat central bank raises interest rates to offset stronger optimism regarding US growth is robust and the Fed
generate excess returns after a disappointing 2018. Among overvalued and the twin deficit making a possible comeback growth and inflation risks, real interest rates are further remains hawkish, the former is likely to dominate.
the advanced economy currencies, the GBP, NOK and as a risk factor, limited diversification might improve boosted. This occurred in the early 1980s when the US Should US growth slow markedly, however, doubts
portfolio performance as well. Fed continued to pursue a tough anti-inflationary policy about the sustainability of the twin deficit would in-
just as the Reagan tax cuts came into effect. The crease, which could harm the USD.
combination of expansionary fiscal policy and restrictive
Significant currency valuation adjustments in 2018 monetary policy boosted real interest rates and the
Deviation from fair value vs. USD (in %) and change in carry (interest differential in %) vs. USD USD.
More attractive
20
carry vs. USD Twin deficit does not always hurt the USD
10
Twin deficit (sum of fiscal and current account balance in % of GDP) and US dollar index (DXY)
0 140 20
130 15
-10
More attractive
valuation vs. USD 120 10
-20
110 5
-30
100 0
-40
90 -5
-50 80 -10
-60 70 -15
1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 2017
THB NZD CHF CNY CAD BRL AUD PHP JPY EUR MYR IDR PLN RUB GBP NOK MXN SEK ZAR TRY
Change in carry (YTD) Last data point 2017 Twin deficit (right-hand scale) * The DXY is an index of the value of the US dollar relative
Last data point 10 October 2018 Source Federal Reserve Bank of St. Louis, to a weighted basket of six major foreign currencies.
Deviation from fair value (latest value) US dollar index (DXY)*
Source Bloomberg, Credit Suisse Credit Suisse

Financial Markets Investment themes
Investment Theme 1:
Interest rate normalization
themes 2019
The cycle is at an advanced stage, but recession is still not Equities, commodities tend to outperform
imminent and central banks continue to normalize interest As one would expect, equities tend to rally strongly in the
Every year we determine our top investment themes. This time rates. Against this backdrop, investors inevitably wonder later stage of the expansion. Within equities, small caps
we focus on: Interest rate normalization; Regional economic how to invest. We favor keeping a growth tilt in portfolios.
This means focusing on assets that have consistently
have underperformed large caps and cyclicals have quite
consistently outperformed defensives.
divergence; and New geopolitical regimes. We will continue to outperformed during the later phase of past expansions,
update these themes throughout the year to reflect changes while reducing market exposure by diversifying into more
uncorrelated sources of return.
The USD has on average depreciated in the latter third of
past expansions but there is a lot of variation across cycles,
in the Credit Suisse House View. so this is far from certain. In contrast, commodities and
What can we observe from past cycles? On average, US especially gold have tended to appreciate consistently.
bond yields have risen and the curve has flattened in the
later stages of expansions. However, it is important to Opportunities for active managers
divide this into pre-Volcker shock (i.e. before the US In summary, reducing market exposure should be intuitive
Federal Reserve raised the federal funds rate to 20% in given the exceptional bull market in this cycle. Additionally,
1981) and post. Bond yields began trending higher along tightening monetary policy and high valuations mean that
with inflation in the early 1950s, peaked in 1981, and then forward-looking returns are likely lower than they have
trended lower until 2012. This is important because any been. All these factors should benefit active managers.
cycle analysis of bonds will mostly be driven by whether the Alpha (uncorrelated returns) has been in short supply this
How much further can real yields go? longer-term trend in yields was up or down. cycle. High cross-market correlations and low macro
Real yield and inflation expectations (derived from 10-year US Treasury Inflation-Protected Securities, volatility have made it very difficult to add value without beta
12-month moving averages, in %) Low yields make credit unattractive (market) exposure. Going forward, volatility is likely to be
Whether yields behave like the post-1981 era or the 1950s higher, correlations are likely to be lower, and divergences
to 1980s period depends on the inflation outlook. For now, between economies and assets more pronounced. Reduc-
5 we do not believe inflation is likely to break out of its ing beta can be achieved by adding exposure to absolute
25-year range, and thus the extent to which bonds can return strategies that aim to be uncorrelated across market
enter a bear market is limited. This does not mean yields environments. Actively managed hedging strategies can
4 cannot rise; it just means the terminal federal funds rate is also help mitigate risk, while reducing the drag on returns
likely to once again be lower than in the previous economic compared to other hedges like buying put options.
cycle. Additionally, today’s low level of yields and very flat
curve make it very difficult to obtain a positive return on
3
bonds, especially outside the USA. Elsewhere in fixed
income, one of the more consistent patterns we can
observe from past cycles is that credit spreads tend to
2 tighten early in the cycle, trough around three quarters of
the way through the expansion, and then widen in the latter
phase. Given the low level of yields this time around, credit
1 seems quite an unattractive late cycle investment.
1998 2002 2006 2010 2014 2018
Inflation expectations Inflation expectations (average)

Last data point 30 October 2018
Source Bloomberg, Credit Suisse Real yield Real yield (average)

Financial Markets Investment themes
Theme 2: Theme 3:
Regional economic divergence New geopolitical regimes
Differences in the relative strength of labor markets and Current accounts make the difference The last 40 years have seen increasing globalization and Were such a risk to materialize, it is likely that the bond/
economic growth between countries have led to large There are also a number of divergences in EM that will free trade, deregulation and a focus on reducing the role of equity correlation would reverse, which would reduce
divergences in global monetary policy, driving growing likely persist over the coming year. Current account surplus the state in society. These policies created three decades diversification in portfolios, and real assets like commodities
interest rate differentials and large currency moves. This economies should be less vulnerable, while current account of strong global growth, which was accompanied by and Treasury Inflation Protected Securities (TIPS) would
has incentivized capital to flow into the USA, pushing the deficit countries should be more vulnerable. If the capex moderate inflation, low macroeconomic volatility and ever benefit. To be clear, we are not likely close to a real inflation
USD higher, but has also exposed weaknesses in emerging cycle in developed markets (DM) continues to pick up more integrated global markets. shock, and it would probably need a severe economic
markets (EM) with large imbalances, like Argentina and steam, this contrast should become even larger, as surplus slowdown to happen. However, buying cheap inflation
Turkey. This helped drive further capital into US assets, economies would benefit from a large rise in DM imports. The rise of populism protection when it is available makes sense. As populists
creating a vicious cycle for EM. For investors, it is important If global growth slows down, most surplus countries should With the positives came unintended consequences: boom favor fiscal expansion, the equity markets of countries
to look for large divergences between fundamentals and be able to pursue counter-cyclical measures, whereas and bust cycles; a sharp fall in the bargaining power of most able to provide this stimulus should outperform,
prices in order to find attractive investment opportunities. deficit countries would likely face a worsening growth- labor; and rising inequality. This inequality was driven by a which at present means the USA and China. China is
inflation trade-off. Trade tensions are also important, and decline in real wages for mostly blue collar workers, who clearly not populist, but the government has the ability and
Central bank policy in focus we think they are likely to remain elevated between the now had to compete with lower cost offshore centers. This willingness to use fiscal stimulus, which is also its main
Monetary policy tightening cycles tend to flatten yield USA and China. Yet China will use a combination of meant communities that depended on those jobs saw defense against US trade tariffs. We favor being short
curves. Given that the Federal Reserve (Fed) continues to stimulus and currency depreciation to offset any real impact declining standards of living and rising unemployment and duration government bonds in the Eurozone vs. the USA.
tighten monetary policy, the recent US curve flattening on growth. crime, further compounding the sense of being left behind.
should continue. And as Eurozone growth starts to catch up The response of policymakers to recent crises helped Demographic shifts
and the European Central Bank becomes more hawkish, It is important to look for large divergences between support one of the largest bull markets on record, again In addition, population aging is continuing, and the baby
the Euro rate curve should also flatten. In contrast, the fundamentals and prices in order to find attractive invest- helping the owners of capital and creating a recovery boomers will soon start focusing their spending mostly on
Bank of Japan has implemented a yield curve control policy ment opportunities. This means that in some cases, where perceived to have benefited the few at the expense of the healthcare. This will be a drag on growth and a strain on
that has capped the level of 10-year yields, hence any prices have moved very far from fundamentals, it may make many. Immigration has given disillusioned voters an easy healthcare and social security programs, and will have to
pullback in accommodation will likely have the opposite sense to own current account deficit countries or to sell target for their anger and a focus for opportunistic politi- become a key focus of policymakers and a further
effect of steepening the curve. current account surplus countries. The election in Brazil has cians and ideologues. All of this has led to the rise of challenge to the fiscal situation. We suggest owning select
created volatility, which we think is unwarranted. Russia populism, which is likely to gather further momentum. parts of the healthcare sector, which should benefit from
Wages on the rise should benefit from the increase in oil prices and has some increased demand as the baby boomers age, as well as
In equity markets, there is a trade-off between higher of the strongest fundamentals and most credible economic Trade and inflation pose risks parts of the tech sector that aim to automate and lower
wages and interest rates hurting margins and the higher policymaking in EM. Israel has a strong balance of pay- So what are the implications for markets? First we should costs in healthcare as well as improve the patient experi-
growth that comes with it that could offset the negative ments and a healthy economic outlook. However, South assume that the current tensions between the USA and ence in old age. Our Silver Economy Supertrend is a good
impact of rising costs. Countries that provide more fiscal Korea is highly exposed to trade and globalization and is China will continue, but any economic impact would likely way to position for this shift.
support and sectors that are less exposed to the impact struggling to transition to a more domestically focused be offset by Chinese fiscal stimulus. Beyond trade, the
of higher wages and rates because they are less capital economy. South Africa has growing external debt and a main risk we see is around inflation. Investors have been
and labor intensive or have lower leverage should also widening deficit. It is also subject to a lack of structural conditioned to believe that inflation cannot rise meaningfully
outperform. reforms and ongoing political uncertainty. Combined, these and thus neither can bond yields. But this has been a
factors make it one of the countries more exposed to unique period in history and current populists, if left to their
external risks. own devices, would clearly pursue policies that would
reverse many of the disinflationary forces of the past 30
years. Combined with high debt levels and an unsustainable
fiscal trajectory, this creates a key risk. To be clear, we are
not forecasting such a scenario. We are simply pointing out
an asymmetry of market pricing. A rise in global inflation
expectations to levels that were normal before 2007 would
likely result in a material repricing of asset markets.

Calendar 2019
Milestones 2019
summits & elections
meetings (presidential & parliamentary)
Note Not all central bank meetings are listed.
January February March July August September
22 – 25 January | Switzerland 07 February | United Kingdom 19 / 20 March | United States 25 July | Eurozone Late August | United States 12 September | Eurozone
World Economic Forum Bank of England monetary FOMC meeting ECB monetary policy meeting Economic Policy Symposium ECB monetary policy meeting
Annual Meeting policy committee meeting Jackson Hole
07 March | Eurozone
ECB monetary policy meeting
24 January | Eurozone 18 / 19 September | Japan

European Central Bank (ECB) 31 March | Ukraine 30 / 31 July | United States BoJ monetary
monetary policy meeting Presidential elections FOMC meeting policy meeting
29 / 30 January | United States 29 March | UK/European Union

Federal Open Market Committee Brexit deadline for the UK to leave 29 / 30 July | Japan 25 – 27 August | France 17 / 18 September | United States
(FOMC) meeting the European Union BoJ monetary policy meeting G7 Summit FOMC meeting
April May June October November December

12 – 14 April | United States 30 April / 1 May | United States 18 / 19 June | United States 27 October | Argentina 05 November | United States 10 / 11 December | United States
Spring meeting of the World Bank Group FOMC meeting FOMC meeting Presidential elections Off-year elections FOMC meeting
and the International Monetary Fund
06 June | Eurozone 20 October | Switzerland 12 December | Eurozone
ECB monetary policy meeting Federal elections ECB monetary policy meeting
24 / 25 April | Japan 31 October | Eurozone

Bank of Japan (BoJ) 26 May | Belgium 28 / 29 June | Japan End of ECB President
monetary policy meeting Federal elections G20 Summit Meeting Draghi’s term
31 October | European Union

17 April | Indonesia 23 – 26 May | European Union 19 / 20 June | Japan End of European Commission 18 / 19 December | Japan
Presidential elections European Parliament elections BoJ monetary policy meeting President Juncker’s term BoJ monetary policy meeting

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Impressum
Authors / Contributors Imprint
Marisa Drew Jessie Gisiger Editor-in-chief

Chief Executive Officer, Senior Analyst, Credit & Equity Strategy Oliver Adler
Impact Advisory and Finance Department Chief Economist Switzerland
Matthew Lehmann
Anja Hochberg Head of Multi Asset Strategy Managing editor
Head of Impact Advisory and Finance, Nannette Hechler-Fayd’herbe
Investment Solutions & Products Daniel Rupli Global Head of Investment Strategy & Research
Head of Single Security Research, Equity Credit
James Sweeney Editorial support
Global Chief Economist and Reto Hess Christa Jenni
Regional Chief Investment Officer Americas Senior Analyst, Equity Research Catherine McLean Trachsler
Christine Mumenthaler
Michael O’Sullivan Sascha Jucker Flurina Krähenbühl
Regional Chief Investment Officer Economist, Swiss Macro Economics & Strategy
Europe, Middle East and Africa Product management
Tobias Merath Camilla Damm Leuzinger
John Woods Chief Operating Officer and Business Management, Sebastian Zeuner
Regional Chief Investment Officer, Asia Pacific Investment Strategy & Research
Editorial deadline
Sylvie Golay Markovich 09 November 2018
Head of Financial Markets Strategy
Design
LINE Communications AG
More information
credit-suisse.com/investmentoutlook
Photo sources
Angela Lumsden/Stocksy (cover, p. 2); Credit Suisse (p. 4)
Christian Grau (p. 9); Melanie Kintz/Stocksy (p. 6, p. 14);
GIC/Stocksy (p. 16); JP Chookaszian/EyeEm (p. 22);
Terry Wong/EyeEm (p. 26); Jeremy Koreski/Stocksy (p. 7, p. 38);
Marcel/Stocksy (p. 40); Gab Gomez/EyeEm (p. 46);
Sardor Kazi/Stocksy (p. 50).
Information sources
Bloomberg; CBS News; CNBC; CNN; New York Times;
Thomson Reuters Datastream; The Guardian; Time (p. 10, 11)

Notes
66 Investment Outlook 2019

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P.O. Box 100
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Investment

As I present our Investment Outlook 2019, a year that

The House View is an

essential part of the

trust we earn and the

Contents 04 Letter from the CEO

6 Investment Outlook 2019 credit-suisse.com/investmentoutlook 7

Most years have a dominant theme that shapes financial

A significant focus will be on

the factors that can prolong

8 Investment Outlook 2019 credit-suisse.com/investmentoutlook 9

2018: The year

09 January 27 April 30 August 13 September 30 September

MSCI AC World total return index

10 Investment Outlook 2019 credit-suisse.com/investmentoutlook 11

Drivers likely to The best of all

12 Investment Outlook 2019 credit-suisse.com/investmentoutlook 13

Inflation on the move

Eye on emerging markets

Stimulus fades, but A resolution of the trade

16 Investment Outlook 2019 credit-suisse.com/investmentoutlook 17

Companies keep investing

18 Investment Outlook 2019 credit-suisse.com/investmentoutlook 19

1998 – 2001 2002 – 2008 2009 – 2013 2014 – 2018

20 Investment Outlook 2019 credit-suisse.com/investmentoutlook 21

Inflation in developed markets is back at pre-crisis levels

2005 2007 2009 2011 2013 2015 2017

Last data point Q3 2018 * Developed markets: Developed markets

22 Investment Outlook 2019 credit-suisse.com/investmentoutlook 23

Emerging markets take a different path

24 Investment Outlook 2019 credit-suisse.com/investmentoutlook 25

The global economy’s Corporates have significantly

26 Investment Outlook 2019 credit-suisse.com/investmentoutlook 27

Similar to the USA,

Fiscal balance Current account balance

* The z-score (or standard score) offers a Germany

Non-financial corporate Federal budget United Kingdom

Last data point Q2 2018

Last data point 2017

28 Investment Outlook 2019 credit-suisse.com/investmentoutlook 29

The trade dispute with the USA or

other potential shocks pose a dilemma

for China’s policymakers, as they

may need to provide renewed stimulus

to prevent a sharper growth slowdown.

But a crisis seems unlikely.

Canada 3.0 2.3 2.1 1.6 2.2 2.2

India Germany 2.5 1.8 2.0 1.7 1.9 2.1

Italy 1.6 1.0 0.9 1.3 1.3 1.4

United Kingdom 1.7 1.2 1.5 2.7 2.5 2.2

Malaysia Japan 1.7 1.3 1.0 0.5 0.8 0.8

Australia 2.2 3.2 2.8 2.0 2.2 2.3

Brazil 1.0 1.8 2.3 3.5 3.7 4.3

Thailand Last data point 08 November 2018

30 Investment Outlook 2019 credit-suisse.com/investmentoutlook 31

The ties that bind: Regional performance

32 Investment Outlook 2019 credit-suisse.com/investmentoutlook 33

Supertrends: Why sustainable

34 Investment Outlook 2019 credit-suisse.com/investmentoutlook 35

Last data point Q3 2018 * Developed markets: Developed markets

* The z-score (or standard score) offers a Germany

late cycle growth most for global