2019 Midyear Market Outlook

Realistic About Risk

Given extended valuations and weaker corporate earnings, investors should
consider tactical adjustments in managing exposure to global equities.
The outcome of the ongoing trade negotiations and the path of U.S. interest rates are going to be the two most importance macro themes for the remainder of the year.  Regarding trade, while the recent G-20 meeting between President Trump and President Xi eased tensions, it did not make the path to a negotiated solution any clearer. Both the U.S. and China appear willing to sacrifice weaker economic growth in the short term in order to achieve longer-term strategic objectives, which are broader issues that will prove difficult to solve. Uncertainty around trade impacts business confidence and sentiment and is detrimental to global growth, via lower productivity and less efficient supply chains. Certain companies may be forced to move or create new supply chains entirely. 

Regarding the Federal Reserve and the potential for interest rate cuts, market participants have now priced in three cuts over the next year, after the Fed signaled (at its June meeting) a willingness to do so.  The first cut could happen as soon as the July meeting. Weaker global growth and deteriorating growth in the U.S., along with subdued inflation, may be sufficient for the Fed to act.  The expectations of future cuts have supported risk assets after a challenging month of May. Equities, bonds and gold all rallied sharply.  Despite the rally, it is difficult to paint a positive long-term picture for risk assets. The trade war effects are just beginning to be felt, and they will negatively impact corporate earnings as well as growth in China and in its trading partners.

Additionally, U.S. politics is in a period of gridlock. With the Democrats taking over the House in 2018, oversight of the Trump administration has increased, and negotiations over a multitude of issues will be fraught. This is at a time when Washington needs to function.
U.S. Cyclically-Adjusted Price-to-Earnings Ratio (CAPE) 1
Source: Yale Economics Department, 31st December 1900 to 31st May 2019.
In Europe, you have the Brexit debacle, a struggling Italian economy and several key EU politicians facing wavering popularity in Germany and France. Recent economic data out of Germany have slowed. The EU will be a source of ongoing political risk for years to come.
Investment decisions in the current environment need to take into account the uncertainty around trade and the future path of interest rates where global growth is deteriorating. Within global equities, investors should consider becoming more tactical in managing exposure, given extended valuations and weaker corporate earnings. Active management, where managers can potentially identify winners and losers from the trade war or find growth in an environment lacking growth, should perform well, in our view. Despite low yields, fixed income can provide some portfolio ballast if economic conditions worsen. Additionally, gold could perform well in an environment where the Federal Reserve is cutting interest rates and the U.S. dollar could weaken.

Lastly, the market structure today, with the large increase in passive investments, algorithmic trading and limited risk taking at investment banks, is not truly recession-tested. Volatility is back, and it is inversely correlated to liquidity. Sell-offs are likely to be exacerbated.
2019 Midyear Outlooks
Brandywine Global
Growth: Turning a Corner
Clarion Partners
The Momentum Continues
ClearBridge
Cautious Optimism for Equities
EnTrust Global
Realistic About Risk
Martin Currie
Looking Beyond the U.S.
QS Investors
Where Do We Go from Here?
RARE Infrastructure
U.S.-China: Fallout from Trade Tensions?
Royce & Associates
Cyclical Thinking
Western Asset
Resilient Growth, Despite Uncertainty

Investment risks:

Yields and dividends represent past performance, and there is no guarantee they will continue to be paid.

Active management does not ensure gains or protect against market declines.


Definitions:

The cyclically adjusted price-to-earnings ratio (CAPE) is defined as price divided by the average of ten years of earnings, adjusted for inflation.

"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.

The Group of Twenty (also known as the G-20 or G20) is an international forum for the governments and central bank governors from 20 major economies. The members include 19 individual countries—Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom and the United States—along with the European Union (EU). The EU is represented by the European Commission and by the European Central Bank.

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

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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.

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