A sizable number of investment managers have published 2019 market outlook reports to coincide with the arrival of the New Year, offering their take on recent volatility and their expectations for what the next 12 months could bring.
Echoing the language of most managers offering up their projections, Northern Trust “does not foresee a recession in developed markets in 2019.” Instead, the firm expects the global economic expansion to continue, but at a modestly slower pace and with recurring bouts of volatility.
Northern Trust points to the absence of the typical signs of the end of a business cycle. These are described as “surging wages and commodity prices.”
“Plus, the prospects for some improvement in China, Europe and Japan remain,” the Northern Trust outlook report says. “China’s stimulus efforts should help its growth to reaccelerate in the second half of the year, providing that trade frictions between it and the U.S. do not significantly increase.”
The firm further states that accommodative monetary policy should provide a floor for slowing growth in Europe and Japan, making valuations more attractive. However, the firm “believes it is very important that the U.S. Federal Reserve does a better job of signaling to the markets that it understands the impacts its monetary policy tightening has had thus far—and credibly telegraphs a course correction in its interest rate trajectory in 2019.”
While the Northern Trust report voices various points of optimism, the firm notes that its 2019 outlook takes a risk-neutral position on its global asset allocation model. This is the first report to take this position since 2009, standing in stark contrast to its significant overweight to risk assets at the beginning of 2018.
On the fixed-income side, Northern Trust’s most favored asset class for 2019 is U.S. high yield bonds, for which it is forecasting a 9.9% return. Its forecast is 3.8% for U.S. investment grade bonds and 2.4% for cash.
“We don’t expect a recession to unfold over the next year in the U.S., so the current rise in volatility is more likely the symptom of a normal market correction than the start of a bear market,” says Jim McDonald, chief investment strategist for Northern Trust. “In this lower return environment, we like the return prospects for U.S. high-yield bonds, which should benefit from a relatively strong current yield and strong fundamentals. We expect this to reduce downside risk but also offer good potential for upside market participation.”
Managers probe for insight about market cycle
Another 2019 outlook report shared with PLANSPONSOR this week came from Manning and Napier Advisors. While still voicing some optimism, Manning and Napier’s outlook seems somewhat more muted.
“Volatility has increased because the U.S. is in the later stages of the economic cycle,” the firm’s outlook suggests. “Economic growth has likely peaked, and slower rates of growth should be expected in the quarters ahead. As growth slows, market volatility will likely remain. Our increased concern for U.S. growth comes at a time when key global risks have escalated, including trade tensions, slowing Chinese growth, and geopolitical uncertainty.”
According to Manning and Napier, among these risks, excessive U.S. corporate debt is a key concern.
“Taking advantage of ultra-low interest rates, businesses spent years loading up on cheap debt,” the firm explains. “Should rates move higher, fears over debt sustainability could trigger a recession.”
Like Northern Trust, Manning and Napier still concludes a recession remains less than likely for 2019, though the picture for 2020 and beyond is more uncertain.
“While we see several key risks emerging in the market, classic end-of-cycle indicators are not yet flashing warning signs,” the outlook report says. “At this time, the U.S. business cycle’s drivers are still well-supported. With rising risks all over, lower future returns should be expected.”
Looking Ahead, Manning and Napier favors higher-quality businesses and reasonably-priced growth companies that tend to provide downside protection in riskier market environments.
“We are lowering exposure to many economically sensitive names and tech stocks,” the report says. “Growth has been sluggish everywhere. Even U.S. growth, which is enjoying a brief uptick, is expected to slow considerably. Poor demographics (particularly with Baby Boomers aging out of the workforce), low productivity growth, and high debt levels are conspiring to hold back growth.”
The report notes the negative impacts of globalization and income inequality are driving a feeling amongst many that the economy “simply isn’t working anymore.”
“The resulting discontent has led to a surge of populist sentiment around the world—such as Brexit in the UK, as well as in the election of populist leaders in Italy, Hungary, Brazil, the US, and most recently, Mexico,” the outlook report says. “Although populist victories are not necessarily problematic for markets, populist policies can hurt economic growth. Already, populism has led to tariffs, supply chain disruptions, and a vast increase in spending.”
Other managers ask, bull or bear for 2019?
John Lynch, chief investment strategist for LPL Financial, notes that the end of 2018 did not technically deliver a bear market, “but it sure felt like one.”
“From its September 20 high through Christmas Eve, the S&P 500 Index fell 19.8%, including a more than 7% one-week (December 14 to 21) decline, unmatched since the 2008 to 2009 financial crisis,” Lynch says. Had the S&P 500 ended the month where it closed on Christmas Eve, December would have marked the third-worst month ever for stocks, he explains.
As the markets swing up and down by multiple percentage points on what seems like a daily basis, Lynch says investors have had a lot to digest, “including the risk of a policy mistake by the Federal Reserve, the China trade dispute, a government shutdown, cabinet-level departures from the White House, the United States’ decision to pull troops out of Syria and Afghanistan, and communication mishaps by the Fed and Treasury Secretary.”
According to Lynch, these issues have given market participants a little too much uncertainty to just shrug off. But, as he points out, bear markets and corrections are not always accompanied by lasting and painful recessions, so market participants should keep the market frothiness in perspective.
“A look at the non-recessionary bear markets offers some reassurance,” he says. “Three of the past four non-recessionary bears ended at 19% corrections—reaching the 20% threshold during intraday trading. The fourth, the 34% decline in 1987, occurred under very different conditions. The S&P 500 was up more than 40% year to date in August 1987, compared to just below 10% through the September 20, 2018, high, while long-term interest rates shot up from 6% to 9% in 1987. So while bear markets can occur without a recession, if the economy is still growing, market declines tend to stop at around a 20% decline.”
Including 1987 and the four other non-recessionary bears before then (1947, 1962, 1966, and 1978), the average non-recessionary bear market decline is 24%, according to Lynch.
“With stocks having nearly reached that point, the selling appears overdone to us, especially when considering the solid fundamentals supporting growth in the economy and corporate profits for 2019,” he concludes. “Despite the many pressures on investor confidence, we continue to believe the fundamental backdrop supporting growth in the economy and corporate profits remains sound, suggesting that this market weakness may not lead to a recession in 2019.”
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