In the coming year, tightening labor markets, rising wages and reasonably strong economic activity in the US will continue to lead the Federal Reserve (Fed) to increase rates. There is, of course, a risk that the Fed will tighten too quickly, and that the combined effects of balance-sheet reduction and conventional rate hikes may contract economic growth much earlier than expected in 2019; while this is not our central forecast, it is a risk we remain acutely aware of.
Higher rates are not going to be good news for some expensive equities out there (especially for the stocks of companies which have gorged on cheap liquidity for the last decade), as among other things they mean higher borrowing costs. As such, we expect to see volatility persisting in equity markets for some time to come.
Clearly, there is a risk that the global trade war that came to the fore in 2018 will worsen in 2019, bringing with it the wrong type of inflationary pressure – that is, the regulatory-driven kind. This has the risk of ushering in a sharp slowdown to global activity, while pushing central banks towards more tightening measures – an unpleasant combination for equity markets.
Looking at Europe, uncertainty around Brexit – specifically the shape of the final ‘divorce’ deal – and Italian sovereign risk will both be a preoccupation for markets. Central bank policies will also remain an important focus, in the context of economic momentum which could be weakening across the European Union, China and the US.
Opportunities for Long-term Investors in 2019
The market is also becoming increasingly anxious about risks of a recession, which is likely to add further volatility in 2019. There is certainly the potential here for investors with a shorter time horizon to be spooked. However, we believe these risks create opportunities for long-term investors such as ourselves. Specifically, to initiate holdings in companies that we see as being exposed to long-term secular growth drivers at attractive valuations.
From our standpoint as international equity specialists, we continue to see a huge amount of opportunity for investors looking beyond their domestic markets. For instance, optically, emerging market equities are around their long-term price-to-earnings average. However, we believe the asset class still represents good value in terms of an international equity allocation. Return on equity is fairly synchronised with developed markets, as represented by the MSCI World index. Importantly though, price-to-book and price-to-equity values remain low relative to history and developed markets.
Attractive Emerging Market Valuation
Source: Bloomberg, as of 10/31/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Meanwhile, despite M&A activity in 2018 reaching record levels (both in the number of deals and the size of those transactions), we believe the market might be underestimating the possibility for this activity to accelerate even further in 2019. This will have the potential to bring periods of euphoria to the market as we have seen in the past at this late stage in the cycle.
The ESG Perspective in the Coming Year
Elsewhere, from an Environmental, Social and Governance (ESG) perspective, we are going to see an enhanced level of focus on climate-change reporting in 2019 and beyond. Both investors and companies will need to think more about how they manage and report on systemic issues such as the recommendations from the Task Force on Climate-related Financial Disclosures (TFCD) and the UN Sustainable Development Goals (SDGs), specifically goal number 13 – Climate Action. For companies, this is a matter of strategy and sustainable value creation. For investors, particularly like ourselves with longer-term time horizons, these (climate-related) systemic risks will be increasingly reflected in valuation models and incorporated into engagement with company executives and board members.
For some companies, increasing focus from investors on transparency also poses a risk. As we move into 2019, the World Benchmarking Alliance, a body set up with the aim to fill the accountability gap in measuring corporate performance in relation to the SDGs, will start to publish publicly available benchmarks. These will rank companies on their performance and incentivise business action towards achieving the SDGs.
Finally, the issue of plastic waste has generated significant attention in the past year and is therefore likely to feature even more prominently in our thinking in 2019. As global awareness of this problem rapidly increases, the phasing out of single-use plastic will move higher up the agenda for both consumers and investors alike. This is already having significant implications for some consumer goods companies, as well as those within the plastics value chain, so we will be spending considerable time understanding how business models (and ultimately long-term margins) will be changed by a drastic reduction in plastics use.
2019 Investment Outlooks
The Limits of U.S. Growth
An Extended Business Cycle
Liquidity is the Question
A Plethora of Risks
Current Volatility, Long-Term Opportunity
Choppy Markets Ahead
Time to Get Defensive?
Royce & Associates
A Shift Toward Cyclicals
Focus on Growth
Download The Full Report
"Brexit" is a shorthand term referring to the UK vote to exit the European Union.
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.
Mergers and acquisitions (M&A) is a general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.
The MSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI World Index is an unmanaged index of common stocks of companies representative of the market structure of 22 developed market countries in North America, Europe, and the Asia/Pacific Region. The index is calculated without dividends, with net or with gross dividends reinvested, in both U.S. dollars and local currencies. Please note an investor cannot invest directly in an index.
The price-to-book (P/B) ratio is a stock's price divided by the stock’s per share book value.
The price-to-earnings (P/E) ratio is a stock's price divided by its earnings per share.
Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder's Equity.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
Any information, statement or opinion set forth herein is general in nature, is not directed to or based on the financial situation or needs of any particular investor, and does not constitute, and should not be construed as, investment advice, forecast of future events, a guarantee of future results, or a recommendation with respect to any particular security or investment strategy or type of retirement account. Investors seeking financial advice regarding the appropriateness of investing in any securities or investment strategies should consult their financial professional.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results.
Please note that an investor cannot invest directly in an index.
Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
Investment in real estate entails significant risks and is suitable only for certain investors as part of an overall diversified investment strategy and only for investors able to withstand a total loss of investment.
All investors in the UK, professional clients and eligible counterparties in EU and EEA countries ex UK and Qualified Investors in Switzerland.
Issued and approved by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia:
This material is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827) ("Legg Mason"). The contents are proprietary and confidential and intended solely for the use of Legg Mason and the clients or prospective clients to whom it has been delivered. It is not to be reproduced or distributed to any other person except to the client's professional advisers.