2019: The Road Ahead

2019 Market Drivers

We see investors focusing on three primary factors this year: the economy, the Fed, and Washington. Of the three, the state of the economy is most critical to the performance of financial markets in 2019.

The Economy, Stupid

2019 will be all about the U.S. economy. The Q4 slide in stocks was in part blamed on recession fears. While U.S. economic fundamentals are robust, the concern is that some combination of international weakness, trade disputes, politics, and the Fed rate increases will stall growth. Some are pointing to weaker data recently as evidence of cracks, but we do not see anything that we believe would precipitate a U.S. recession in the next year. Equities could rally if uncertainty about some of these headwinds dissipates.

The Fed Effect

This could be the year the Federal Reserve declares that interest rates have reached neutrality – the level where they are no longer stimulating or putting the brakes on economic growth. That may turn attention to Quantitative Easing (QE), which is the other tool in the Fed’s toolkit that needs replenishing. Rolling back QE could help steepen the yield curve, but would also make financing more expensive (a drag on the economy) and could strengthen the dollar (a problem for Emerging Markets). We expect the Fed to err on the side of caution, avoiding the accelerator and, at most, tapping on the brakes.

Political Gridlock

With a split Congress, Washington may face increased gridlock. Financial markets have historically been content for the legislative agenda to grind to a crawl. However, more uncertain will be the impact of the potential conclusion of the Mueller investigation and the increased scrutiny on the President that the Democratic House will bring. While fireworks appear inevitable, onlookers may be surprised how little an impact they will have on markets. Investors can sit back and (try to) enjoy the show.

Market Predictions

Contributed by Max Berkovich

The Bounce Back

• 15% upside from the S&P 500 seems difficult to achieve, but that would only put us back to where we were in September of 2018.
• If the Federal Reserve eases its tightening path, trade issues with China get some resolve, and some civility returns to the Capital, we would see 15% as a very low and achievable hurdle.

Value’s Turn Still

• While Growth stocks had their year in 2017 and most of 2018, we expect fundamentals to drive returns for stocks in 2019, favoring Value.
• As growth starts to moderate, we think investors will sharpen their pencils, get their financial calculators out, and look for companies with solid fundamentals.

Quality Right Under Our Nose

• Recency bias of the 4^th quarter sell-off should pull investors back to playing it safe. Companies with a record of consistent execution and profitability should take the mantle back from companies who promise to execute and deliver in the future.

Sizing Things Up

• We see Small Cap stocks grabbing the lead from Large Cap. We expected this in 2018, but they failed to achieve.
• Smaller companies tend to be domestic focused and should be at least relatively insulated from a global slow down.
• Small Cap stocks are also more apt to benefit from the strong labor market and now expanding incomes at home.

Moment of Um

• The past decade has been a good time to buy the winners, pushing those “hot” stocks to nose-bleed valuations. We think that will reverse in 2019 and a “new” class of momentum stocks will emerge. This group will be less cyclical and most likely cheaper than the current group.

Volatility

• After a volatile 2^nd half of 2018, we believe 2-3% moves in equities will be more prevalent, and investors will accept it as the new normal, but investors will appreciate investments that bounce around less.

Harvesting the Force

• Seeing how we think quality, value, smaller capitalization, “new” momentum, and low volatility will be the prevalent factors of out-performance going forward, we have already and will continue to harvest that force by investing in vehicles that use those factors in lieu of basic, market capitalization-based ones.

Interest-ing things

• The Fed is expected to raise rates but at a less aggressive rate, signaling that a normalized rate environment is on the horizon.
• With the recent market sell-off, and talks of a slowing global economy, we expect that yield chasing should shift from buying lower quality to extending duration as weaker credits get shaken out and the yield curve steepens.
• Plain vanilla Fixed income investments should have a solid 2019, but no more than coupon clipping should be expected.