Market Outlook: Global Alternatives

A Plethora of Risks

We believe U.S. economic growth and earnings growth are going to decelerate in 2019.  Fiscal stimulus is fading, and the impact of tax reform will force earnings growth back to levels more typical of an economy in the later stages of expansion. Normalization does not mean recession; however, it is notable how many downside risks exist today.

US-China relationship – Ultimately it is about more than just trade.  The U.S. Vice President’s speech on October 4th made clear there are issues that are strategic in nature, including technology, intellectual property and national security in addition to the trade deficit.  While the Trump-Xi meeting at the G20 Meeting in Buenos Aires has offered a respite from the trade rhetoric that has negatively impacted markets and global growth, the risks of further escalation clearly remain and could impact markets over the course of 2019.

Continued monetary tightening – While the U.S. Federal Reserve may be closer to the ephemeral “neutral” level implying a more data dependent approach, the European Central Bank is set to begin to taper their asset purchases and the Bank of Japan may be forced relax its policies around yield curve control to support their banking system.  Tighter financial conditions can be a headwind to growth.

Margin compression – Rising costs via wage pressures, higher logistics and materials costs may negatively impact margins.  Tax reform was a one-time benefit that will not contribute to earnings growth again in 2019.  With the unemployment rate at the lowest level of the expansion, wage pressures are expected to continue.  In addition, the impact of tariffs will begin impacting margins.

After hovering around 2% for much of the post-crisis period, year-over-year wage growth has recently moved above the 3% threshold. As labor markets are set to further tighten, wage growth pressures are likely to increase, dampening corporate profitability. 

U.S. Unemployment Rate and U.S. Average Hourly Earnings
Source: Bloomberg, as of 10/31/18.

Corporate credit – Widening credit spreads will negatively impact borrowing costs.  Low interest rates enabled companies to increase leverage and engage in large share buybacks to support earnings per share (EPS) growth during the expansion.

Middle East geopolitics – Oil prices below $60 per barrel are not sufficient to meet most Middle Eastern economies budgetary targets.  OPEC and Russia may look to cut production to maintain prices creating further tension with the U.S.

European politics – Brexit and Italy continue to present potential flashpoints that can negatively impact European growth.  The sense of populism is difficult for markets to discount.

Factoring in the potential downside risks described above, market volatility is expected to remain elevated.  As a result, equity markets will be forced to rely on dividends and earnings growth for much of the gains next year as any increase in equity market valuations are unlikely.

Given the outlook above, we generally:

•   Favor Value over Growth strategies in general
   Favor Emerging Markets over Developed Markets
   Expect large caps should outperform small caps
   Believe Quality as a factor should perform well

Lastly, we believe the environment for active management is greatly improved.  The shift from quantitative easing to quantitative tightening will impact liquidity, lead to higher risk premiums and impact corporate performance leading to higher dispersion in equity prices.  

 

2019 Investment Outlooks
Brandywine Global
The Limits of U.S. Growth
Clarion Partners
An Extended Business Cycle
ClearBridge
Liquidity is the Question
EnTrustPermal
A Plethora of Risks
Martin Currie
Current Volatility, Long-Term Opportunity
QS Investors
Choppy Markets Ahead
RARE Infrastructure
Time to Get Defensive?
Royce & Associates
A Shift Toward Cyclicals
Western Asset
Focus on Growth

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Definitions

The Bank of Japan (BoJ) is the central bank of Japan and is responsible for the yen currency.

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.

Developed markets refers to countries that have sound, well-established economies and are therefore thought to offer safer, more stable investment opportunities than developing markets.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.

The European Central Bank (ECB) is responsible for the monetary system of the European Union (EU) and the euro currency

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.

Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities.

The yield curve shows the relationship between yields and maturity dates for a similar class of bonds.

 

Disclosures

Dividends represent past performance and there is no guarantee they will continue to be paid.

Diversification and asset allocation strategies do not assure a profit or protect against market loss.

Investments in small-cap and mid-cap companies involve a higher degree of risk and volatility than investments in larger, more established companies.

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  • Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

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