2019 Outlook and Predictions

Each year our Friend  Bob Doll, who is Chief Equity Strategist & Senior Portfolio Manager at Nuveen asset management, gives his view on the new year.  His insights are very thoughtful and give us some insight to the year ahead.  Below are Bob’s comments for 2019 and how he believes the year will unfold in the Economy, markets and some insight to geopolitical events that could affect your portfolios.

2019: Choppy and frustrating, but no recession

First a look back at a disappointing 2018

2018 proved to be a “Tale of Two Cities” year, as investors were confronted with a range of contradictions: Unemployment ended the year at nearly a 50-year low and wages have been rising, yet fears of a recession have increased. And corporate earnings were amazingly strong while stock prices sank sharply into correction territory by the end of the year. Investors are now left to question whether solid fundamentals or growing uncertainty will shape the markets.

Ironically, 2018 was relatively calm until the fourth quarter. Outside of a brief correction in January and February driven by fears of rising interest rates, investors focused on an accelerating economy and strong earnings growth. Stock prices rose to record levels by the end of the summer.

U.S. economic growth was quite strong in 2018, helped in no small part by the 2017 tax cuts. At the beginning of the year, we believed real U.S. gross domestic product growth would reach 3%.This level was much higher than consensus estimates, but it did come to pass. We also expected corporate earnings growth to rise, but were surprised by the incredible S&P 500 earnings per share growth of 22.6% year over year.1

What happened over the last three months? Stocks may have reached overbought levels by the end of the summer, so it wasn’t shocking to see a selloff. But the magnitude of the decline has been surprising. We see two primary drivers of the current selloff. First is a genuine fundamental issue of higher interest rates and inflation. Neither has been moving strikingly higher, but they have advanced over the last 12 months, compressing equity valuations. Second, consider a large list of worries: concerns over slowing economic and earnings growth and trade issues are the most prominent, but investors are also worried about Brexit, the Italian budget stalemate, falling oil prices, political dysfunction and uncertain Federal Reserve policy. With this somewhat confusing backdrop, Bob offers his 10 Predictions for 2019.

2019 Ten Predictions

  1. The U.S. expansion becomes the longest in history despite GDP slowing to a still-above-trend increase of 2% to 2.5%.
  2. Unemployment bottoms in 2019 while wage growth continues to rise.
  3. The Treasury yield curve flattens and credit spreads widen due to late cycle concerns.
  4. Corporate earnings growth estimates weaken for 2019 and 2020 as both revenue and profit pressures rise.
  5. U.S. equities experience a positive return, but fail to reach record highs for the first time in 10 years.
  6. Non-U.S. stocks outperform U.S. stocks as the dollar sags.
  7. The information technology, financial and healthcare sectors outperform utilities, REITs and materials.
  8. The annual federal budget deficit approaches $1 trillion, a level unprecedented absent a recession.
  9. U.S. and global politics spark more market volatility as the cold wars within the U.S. and with China persist.
  10. A double-digit number of Democrats run for president while President Trump is challenged within his own party.

2019 Outlook

We have many questions, but we think it is fairly certain that the U.S. will not fall into recession in 2019. We don’t see any signals that make a reasonable case for recession. The consumer sector looks strong, particularly the labor market. The corporate sector is solid, although corporate management teams have scaled back some plans due to trade concerns. And the government sector appears to be expanding, as spending is likely to rise. We expect growth will slow next year compared to 2018, but to a still-above-trend 2%+ level.

A confusing and conflicted outlook

 

The Bullish View

Solid Earnings Growth

Growth is slowing, not collapsing

Fed is becoming more dovish

Trade issues could improve

Correction has been broad based

Sentiment is very negative

Valuations have improved

 

The Bearish View

Earnings uncertainty is high

Fed Policy is too tight

Tariffs will slow growth

Global growth is unbalanced

Financial Market Volatility could rise

Political uncertainty is pervasive

The end of the cycle is inevitable

 

However, we can easily make a bullish or bearish case for stocks. We could argue that recession fears will likely fade as data continues to be positive. Should that happen, stock prices could again rally on decent fundamentals, especially since valuations are more attractive now than they were a few months ago. Conversely, even if the economy continues to grow, investors will become increasingly concerned about slowing earnings growth. They will continue looking for reasons to sell, which could produce a trendless or even falling market into 2019.

But, at the end of the day, as professional investors we are obligated to make a call and lean toward a constructive view on equities. As the title of our predictions suggests, we think markets will remain choppy and frustrating and stocks will bounce around with extended runs and declines. Ultimately, we think the bullish factors will generally overpower the bearish ones.

We expect 2019 market performance will be stronger than 2018.We think a reasonable year-end target range for the S&P 500 Index would be around 2,650, meaning a decent gain for stocks. To get there, recession fears cannot be realized.

As volatility remains elevated, we think 2019 will be a difficult environment for investors. Remaining selective and tactical would seem to be the order of the day. Long term investors may want to add to positions during periods of weakness and trim holdings during periods of strength.

Additionally, we point to several themes that we think may win out over the course of 2019. Specifically, we think focusing on factors such as high free cash flow, inexpensive valuations, the ability to grow top-line earnings and an eventual tilt toward non-U.S. sources of revenue would benefit 

So long to a disappointing 2018

The equity markets certainly took investors on a wild ride in the holiday shortened week.  On Monday, the Dow Jones Industrial Average lost 650 points; on Wednesday, the markets rallied with the Dow gaining 1086 points, its largest one-day gain in history.  On Thursday, extreme volatility drove the Dow down over 600 points before reversing course to close up 260 points.  For the week, the major indices posted gains for the first time in December, the Nasdaq rebounded from bear market territory gaining 3.97%; the Russell 2000® Index rose 3.55%; S&P 500® Index rose 2.86% and the Dow gained 2.75%.  During the week, the Dow, the S&P 500® and Russell 2000® narrowly missed entering a bear market before the rebound.  Year-to-date, though, the Dow, the S&P 500® and Nasdaq are on track to post their first annual losses since 2008.

Analysts suggest that the major culprit in the dramatic selling action is the concern that the global economy is slowing, or that a recession is looming.  Later in the week, the rebound seemed driven either by those who bought in an oversold market or discounted fears of an imminent recession.  The automated processes of quantitative trading programs, which account for approximately 85% of all trades, are likely responsible for the extreme volatility.  Their trading formulas are closely held secrets; and yet, the algorithms that each utilize incorporate price movements and other data.  They often move in lockstep as each feeds off the others’ program decisions.  Passive investors, which simply follow market momentum, add to the mix.  The problem created by the computer models is that they cannot correctly analyze all data events and human behaviors; as a result, their actions may create unintended consequences, including volatility.  Active investors must, therefore, adapt to the challenge by utilizing market volatility to advantageously buy and sell stocks.  Even so, active investors oftentimes allow the markets to settle down before initiating significant changes.

Following a strong nine months of 2018, the year is ending in disappointment.  The markets seemed overwhelmed by myriad events which overshadowed the health of the U.S. economy.  Several geopolitical events, including a divided Congress, trade disputes, monetary policies, Brexit, and oil prices will demand attention.  By mid-January, the fourth quarter earnings season will provide an important barometer in gauging both the health of the economy and the outlook for the New Year.  Many stocks are greatly undervalued; they will recover as headline events reach resolution and earnings reports shed more light on the outlook for individual companies.   

Best wishes for a prosperous and Happy New Year!

Source:  Pacific Global Investment Management Company

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Chart reflects price changes, not total return.  Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Market Update - the Dow has its biggest daily point gain ever

Today is a great example of the danger of trying to time the market.  In October, November, and December, investor sentiment began to sour, and the markets trended lower.  The S&P 500 sold off 19.8% from September 21, 2018 through December 24, 2018.  The Dow sold off 18.5% and the Nasdaq sold off 22.5% during the same period.  With market losses mounting, 2018 was beginning to feel a lot like 2008.  However, there are sharp contrasts between 2008 and 2018.  

In 2008, the US (and global) economy was saddled with unprecedented levels of consumer debt, housing was unaffordable, consumer spending was dropping, unemployment was climbing, and the global banking system was on the verge of collapse because of the then current consumer debt levels.  Additionally, the earnings per share of the S&P 500 began to fall.  To make matters worse, the US was still operating under "Mark-to-Market" accounting rules that gave businesses few options other than massive write downs on collateralized debt instruments, which in most cases were still paying more than 96% of their expected cash flows.  

In contrast to 2008consumers in 2018 have the lowest debt to disposable income ratio they've had since the early 1980s.  Housing affordability is closer to where it was through most of the 1990s than what it was in 2008.  Consumer spending has been increasing, and it looks like this will be the best holiday shopping season in at least the last 6 years.  We are also currently enjoying the lowest levels of unemployment that we've had in 50 years.  Further, we don't see any "BUBBLES" like we saw in the housing market in 2008 or in Tech stocks in 2000.  Additionally, since 2008 banks significantly increased the quality of their balance sheets, and US businesses are as healthy as they've been in a very long time.  In short, 2018 looks nothing like 2008, other than that the last few months have been challenging for equities.

We continue to believe the US economy will expand in 2019, and current expectations indicate we may expect to see a 12% earnings growth for the fourth quarter of 2018, with earnings growth continuing all the way through the end of 2019.  We have shared some of our concerns with respect to an inversion of the yield curve, but the Federal Reserve has shown it is aware of the current interest rate environment, and the Fed has signaled that should the data support pausing, it would be willing to pause.  Powell's statement in November, that he believed we were very "near" neutral rates, indicates he may think we won't need any more rate hikes in 2019.  To reiterate our thoughts after the Fed's decision to raise rates, we believe Powell was leaving the door open for future rate increases in the event that the trade dispute is settled with China and global growth begins to accelerate again.  However, he also left the door open to pause raising rates in 2019 should the trade war extend for longer than anticipated. 

Lastly, the US and China continue to make progress on trade; resolving the trade dispute is in both their interest and ours.  It's too early to determine if we will meet the 90 day deadline agreed upon by Trump and China, but if we look at what transpired between the US and Mexico and the US and Canada, we have reason to believe we may very likely have a deal near the currently set deadline.  

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