By Stephen Kyne
The year 2018 was an interesting year in the financial markets, to say the least. Characterized by all-time highs in stock indices, two whipsaw corrections, and a nearly 20 percent decline to cap the year off, the year was anything but boring. As it stood at close of business on Dec. 27, it looks like we’re going to end the year down, barring any last-minute surprises.
So, what happened, and where do we think the economy is headed?
First, to be absolutely clear, we do not think a recession is imminent, or even likely for at least another 12-18 months. That may seem contrary to what you are seeing on the news, but the news exists more for ratings than it does to inform Remember, nobody watches the news to see the house that didn’t burn down.
The economy is exceedingly strong, and most factors point to continued strength going into the new year.
With quarterly GDP growth in the 3-4 percent real (inflation-adjusted) range, it is generally accepted that a portion of this growth could be attributed to the effects of tax cuts, but no serious economist would attribute it all to that factor. We expect growth in 2019 sustainably in the 3 percent range. While that may not seem very high, consider that it is 50 percent higher than the roughly 2 percent annual growth we experienced from 2009-2016. The U.S. economy is strong.
U.S. corporate profits in 2018 saw an increase of roughly 25 percent year-over-year, and we expect profits to continue to grow throughout the new year, though at a more modest 10 percent rate.
We fully expect the “trade war” with China to be at least partially resolved early in 2019, with immediate benefits to U.S. businesses. Remember that prior to 2018, China had an average tariff of more than 9 percent, compared to the U.S. average 3 percent tariff. While we can debate how best to resolve that disparity, we cannot debate that the disparity needed resolution.
Tariffs on American goods are already, quietly, beginning to be lowered substantially (Google “Reuters China Tariff” for more information). We don’t expect parity, but any reduction of impediments to trade in the world’s second-largest market will have positive results for the U.S. economy.
The Federal Reserve has raised interest rates, as expected, by 1 percent this year. It should be noted that, while the Fed is raising rates, it’s not being done for the traditional reasons. Often, rates are increased to slow an overheating economy, but current increases are aimed at a return to normalcy.
In other words, since lowering interest rates is a way for the Fed to jump-start a slowing economy, if rates were to continue to remain low, and a recession were to begin, the Fed would not have access to its primary tool, so think of the Fed’s current actions as “reloading” for next time. In this way the Fed is not becoming “tight,” it’s simply becoming “less-loose.” We expect the Fed to increase rates once in 2019, as it weighs economic indicators.
U.S. unemployment continues at near-record lows, with 1 million more job opening than job seekers. Without the ability to hire additional laborers to increase overall productivity, continue to look for companies to adopt new technology and innovate the way they do business, in order to boost output. This pressure should continue to drive growth in the tech sector, and elsewhere.
For the broad U.S. stock indices, we expect growth of better than 10 percent in 2019 (or more, if they end the year much lower). Stock valuations are lower than historical averages, and with profits expected to continue to grow, we see plenty of room to run for U.S. stocks.
That being said, expect volatility to be a theme again, as the uncertain political landscape and polarizing news coverage alternatively weigh on, and fuel the markets.
We are the first generation of Americans to be energy independent. Our new-found and growing access to cheap, domestic energy will continue to help fuel (pun intended), our growing economy and its influence should not be underestimated.
We expect that bonds will continue to lag as interest rates continue to modestly rise. While we do not believe in abandoning diversification in order to chase profits, it may be wise to utilize cash as a proxy for a portion of your bond allocation until rates find “neutral”.
For the rest of the world, we see a mixed bag.
China has continued to slow in its rate of growth, and we expect this to continue throughout 2019. The rest of the world has begun to grow impatient with China, as it attempts to become the dominant world economy. As the U.S.-China trade tensions ease, expect more countries to demand better treatment (re: trade and intellectual property) from China, as well. This will should put further downward pressure on its economy.
Looking to Europe, we expect the UK to be the standout economy, especially as it sorts out its Brexit situation. If nothing else, having its own currency means that it can control monetary policy independently of the rest of Europe. That, coupled with its ability to forge trading partnerships should give it a leg up, compared to the continental powers.
Emerging markets continue to be spotty in their performance, with few winners and many losers this year. Argentina is, once again, on the verge of default and collapse. Venezuela is lost. Russia continues to fight the Cold War, as it attempts to use military might as leverage to replace its waning influence in the energy sector.
On a risk adjusted basis, we see more upside, once again, in U.S. markets, than we see in much of the rest of the world. As we start 2019 we expect to be overweight U.S. stocks, and underweight both developed and developing international stocks. Given all the U.S. has working in its favor, we would be hard pressed to justify drastically increasing exposure internationally.
A stable U.S. dollar and a U.S.-China trade deal may be the catalyst International markets need to rebound from their underperformance.
With the exception of a major geopolitical event, we expect that 2019 will be a positive for the economy as the bull market continues into its tenth year. Since we do expect continued volatility, be wary of making long-term investment decisions based on short-term movements in the market. Given time, the U.S. markets have an undefeated record of recovering from corrections and recessions.
Remember that everything written here is a forward-looking statement, based on our current view of the markets and economy. Any number of domestic or foreign events could drastically alter our outlook.
Your exposure to the various equity and bond markets should depend on your need for return, time horizon, and inherent appetite for risk. Be cautious about overextending and be sure to consult with your independent financial advisor to help ensure that any changes in the economy and markets are reflected in your portfolio, and that your portfolio remains reflective of your needs and goals.