Outlook for 2019: best or worst of times?
“It was the best of times, it was the worst of times …” begins a famous Charles Dickens novel. Unsurprisingly, this phrase has been repeated countless times in financial publications since Dickens wrote A Tale of Two Cities in 1859. Over the past few decades we have seen clear examples of both good and bad times in the global economy. Certainly, last year's stock market plunge in the final quarter was not the best of times for investors, even though the global economy continued to expand.
In terms of what's next, investors seem to be forecasting the worst of times. Despite record corporate profits last year and consensus forecasts for respectable global growth of around 3.5 per cent in 2019, stocks, commodities and credit prices have lately veered to the downside, notwithstanding a recent bump up from December's lows. In any event, we have now had official market corrections of about 20 per cent on all the major stock market averages.
Market nervousness has also been evident in the credit space. Substantially higher credit spreads, or the additional amount of yield investors require in order to underwrite the risk of owning corporate bonds, have expanded to levels typically seen during periods of recession.
For example, last December, high yield bonds experienced their worst month since 2011. However, incoming economic data does not support a recession thesis — at least not at the moment.
The most critical market headwinds are the US-China trade war, tightening central bank monetary policies and likely, concerns over an unruly Brexit negotiation. Market direction going forward will therefore be determined by political leaders rather than traditional market forces. No wonder cautiousness prevails.
In terms of the Fed, America's central bank has simply been proceeding along the lines of its historical pattern: altering monetary policies without regard to the lagging nature of these actions. Bear in mind, the Fed is not just raising interest rates, but also draining liquidity from the system by shrinking its balance sheet through a process known as quantitative tightening, or QT for short.
As I have mentioned here before (“Investing against a hawkish Fed”, November 16, 2018) the Fed often acts as an arsonist firefighter causing crises which they later fix. For better or worse, the agency is bound by its dual mandate of maximum employment and stable consumer prices.
The Fed is therefore at the mercy of backward-looking economic statistics and informed by outdated models which have shown to be much less relevant in this age of mass disruption.
Yet, because the current market headwinds are essentially man-made problems, they can also be unmade with better policies. For example, when Fed chairman Jerome Powell, recently announced a willingness to show some flexibility in the FOMC's double-tightening policies, markets soared on the day.
We also can be hopeful that US President Donald Trump gets a trade deal done with the Chinese. As a first-term president, he certainly needs a deal to improve his credibility after losing the House of Representatives to the Democratic party during last year's midterm elections.
At the same time, China has been negatively impacted by the trade war. Likely because of the new tariffs, the country's exports fell by a record 4.4 per cent in December according to last week's data series. A trade resolution of any kind would allow international businesses to rearrange their global supply chains to more efficiently adapt to new rules, whatever they may be. Present policy uncertainty is crimping business investment and therein lies the biggest problem.
Now this is the point where I go out on a limb and make some predictions for the year ahead:
1. The US and global economy will experience a slowdown but not a meltdown, or recession as some fear in 2019. Markets will remain highly volatile due to escalating geopolitical tensions. However, a trade deal will ultimately be struck between the US and China, propelling markets higher.
2. After forming a solid bottom, which may mean retesting the recent lows, share prices will rise for the 2019 year. The panic sell-off in the fourth quarter of 2018 has washed out some of the weaker hands in the market, setting the stage for a recovery later this year.
3. There will be close to a trillion dollars in stock buybacks, raising earnings per share for the largest companies. Cash rich multinationals will seize the opportunity to buy their own shares at lower prices.
4. Cheaper share prices and still relatively low interest rates will lead to a very good year for mergers and acquisitions. We just saw a large pharmaceutical deal between Bristol Myers and Celgene during the first week of 2019.
5. The Fed will raise interest rates only once or twice in 2019 with no raises in 2020. The yield curve will remain very flat but will not invert (at least between the two and ten-year yields).
6. Value investing will regain favour after several years of extreme underperformance as the large cap tech complex (also known as the “FAANG”) becomes less dependable with returns among the individual companies becoming more divergent.
7. Beaten down income-producing securities, such as pipeline MLP's and hybrid securities will have a great year, seeing further price appreciation on top of coupon payments between five and seven per cent after a challenging second half of 2018.
8. The greenback will stabilise after a strong 2018 as the Fed begins to walk back its monetary tightening policies in the face of decelerating growth.
9. Emerging markets will reverse course from a difficult 2018 and begin to outperform developed markets as the greenback tops out and a trade deal is achieved.
10. Small and mid-cap companies will experience a resurgence in share prices as the Fed relaxes it's tightening policies and Russell 2000 companies show year-over-year double-digit profit growth.
• Bryan Dooley, CFA, is the senior portfolio manager and general manager of LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.