2019 Midyear Market Outlook

Resilient Growth, Despite Uncertainty

Sturdier U.S. growth, improving conditions in Europe and economic stimulus
in Asia should keep global growth positive, even amid trade tensions.
Global markets moved higher in the second quarter, but the path has been erratic with markets either rallying on signs of another dovish pivot by a major central bank—the Federal Reserve (Fed) and European Central Bank (ECB) being the most recent examples—or selling off on fears that the trade spat between the U.S. and China might be broadening and expanding onto new fronts. Although downside risks to the global outlook persist, our base case is that central banks will maintain a highly accommodative posture, global growth will be resilient, and inflation will moderate. In this environment, we believe spreads across global credit markets should continue to grind tighter relative to government bonds. Emerging markets, though volatile, should outperform. 

Key Macro Themes 

Global growth concerns have intensified since last quarter on worries over slowing U.S. and eurozone growth, higher oil price volatility on escalating tensions in the Middle East, and ongoing trade tensions. Looking ahead, we expect global growth to remain resilient on sturdier U.S. growth, improving conditions in Europe, and signs that sustained stimulus across Asia is gaining traction. While trade will remain a source of uncertainty and act as a drag on investor and business confidence globally, it is important to note that the major central banks have become much more explicit in their commitment to unleash additional policy accommodation to truncate downside risks.
The Story of Long-Term Interest Rates Is Largely the Story of Inflation
30-year Treasury vs. Core PCE
Source: Bloomberg, as of 4/30/19. 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.
Chronically Below-Target Core Inflation Is a Global Phenomenon
Core inflation rates: 12-month changes in core consumer inflation
Sources: Bureau of Economic Analysis, Bloomberg, as of 4/30/19. 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.
We see no compelling reason to share the Fed’s optimism that inflation will soon be 2% or higher. Faster nominal spending growth that would push inflation or growth higher has failed to occur, despite all of the Fed’s efforts. The longer that inflation stays at or below the Fed’s 2% target, the more pressure there will be on the Fed to act. We believe the odds favor some development pushing the Fed to cut rates in the second half of this year.

Yield Curve Inversion Is Not Signaling an Imminent Recession

Regarding the current concern about the inversion of the U.S. Treasury yield curve, we note that yield curve inversions have an excellent track record of predicting every U.S. recession since the 1960s. However, our preferred measure of yield curve inversion, the spread from overnight rates to long bond yields, is not inverted presently. The yield curve is currently flat enough that a sustained decline in long bond yields (e.g., on a temporary spike in risk aversion) could result in an inversion, but Fed rate cuts expected later this year, and more evidence of a resilient U.S. economy, should prevent such an outcome.

Areas of Opportunity

In the U.S., we see value in short-dated U.S. Treasurys (given our view of moderate growth and a cautious Fed) and in longer-dated bonds (as a hedge against spread risk). Select investment-grade (IG) and high-yield (HY) corporate credit, as well as emerging market (EM) debt both in U.S. dollar and local-currency denominated forms, also offer attractive carry and total return potential. 
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:

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

U.S. Treasurys are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasurys when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

Outperformance does not imply positive results.

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


Definitions:

A spread is the difference in yield between two different types of fixed income securities with similar maturities; usually between a Treasury or sovereign security and a non-Treasury or non-sovereign security.

The Personal Consumption Expenditures (PCE) Price Index is a measure of price changes in consumer goods and services; the measure includes data pertaining to durables, non-durables and services. This index takes consumers' changing consumption due to prices into account, whereas the Consumer Price Index uses a fixed basket of goods with weightings that do not change over time. Core PCE excludes food and energy prices.

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

Inverted yield curve refers to a market condition when yields for longer-maturity bonds are lower than those of shorter-maturity issues.

U.S. Treasurys are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasurys when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

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

Important Information

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.

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