2019: The Road Ahead
After a tumultuous end to 2018, what do the markets have in store for us in 2019? Should investors be bracing for another rocky ride, or prepare to enjoy the next leg up? We share our thoughts.
Contributed by Doug Walters
Once a year we like to exercise our soothsayer skills and pen our predictions and resolutions for the coming year. No, we did not purchase a crystal ball over the holidays, and yes, we still believe investing is about preparing for, not predicting, the future. But new year predictions are a tradition, and there is value in understanding the factors that are driving investor sentiment, even if the short-term timing and direction of market moves are largely unpredictable.
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.
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.
With our crystal ball in hand, we take to predicting the year ahead. The future is as uncertain as ever (if not more so), but we believe there are plenty of reasons to be optimistic. Our 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 4th 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.
- After a volatile 2nd 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.
- 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.
Contributed by Max Berkovich
In our annual all-Strategic stock picking contest, over 23% of team members selected The Walt Disney Company (DIS). Not surprising as we employ an arsenal of sports fans (ESPN), Star Wars fanatics, Disney theme park visitors, and parents and grandparents of children under 10.
“ For my ally is the Force, and a powerful ally it is.” – Yoda
Catalysts for the year include Disney completing its acquisition of 21st Century Fox and launching of its streaming service. The movie schedule for 2019 includes Captain Marvel, Dumbo, Avengers, Aladdin, Toy Story 4, The Lion King, Frozen 2 and Star Wars Episode 9. Risks to the company include continued cord cutting, escalating cost of programming and competition from other media providers.
Contributed by Doug Walters , Max Berkovich
The investment team is always trying to make improvements. In that light, we have set the following 2019 resolutions:
- More videos and podcasts (it will happen this year!)
- A redesigned Insights publication
- An increased focus on factors beyond Quality and Value
- A sequel to our Star Wars series (A New Rate & The Last Hike)
- Collectively shed 100lbs from the Investment Team by Q3 (excluding the impact of the resolution below)
- Add a new member to the team who embraces the sweater vest as much as we do
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