The global economic expansion will continue, albeit slower into 2019. Estimates are global GDP will slow from 3.7% in 2018 to 3.4% in 2019. Market sentiment is overly negative and there are no signs of a global recession. While the current expansion is stretched, there is still opportunity for another growth phase in equities despite the brewing economic challenges.
The US Fed has recently advised, as of Jan 5, 2019, that they are now “listening carefully to the markets.” This is a complete reversal of Powell’s guidance since the December meeting, so much so that the bond market has now priced in zero Fed fund rate increases in 2019. How things can change so quickly!
Negative market sentiment appears to be pricing in a decline in corporate earnings in 2019, which we believe is incorrect. The estimated S&P500 index earnings for 2018 is $157. The 2019 consensus earnings expectation is $172, for an 8-10% growth rate. Also, top line revenue growth is a stable indicator and strongly supports continued earnings growth (Reuters).
The US economy is the engine of global growth with no recession in sight. Employment and wage growth remains very healthy without inflation pressures. This should shore up consumer confidence and spending. However, US housing is one area of concern as the market has become oversupplied in some areas and 30 year mortgage rates have increased marginally from 4% to 4.5%. But overall, interest rates are relatively low.
Trump continues to be a concern; with the US government shutdown being the most recent negotiating tool used to build the Mexican border wall. We do not believe the US government will cause an extended shutdown as cooler heads will prevail.
What is potentially the biggest risk, besides the Fed again reversing its most current stance, is also the biggest opportunity – US/China trade negotiations. Trump views himself as a businessman and tariffs are just a tool to negotiate better trade agreements. There are indications both China and US are motivated to resolve this issue: for China as their economy is being hurt by the uncertainty around trade, and the US as they do not want to cause a self-imposed recession. We expect this to be a process over time, unlike the USMCA trade agreement that was agreed to in the 11th hour.
Oil prices collapsed by 36% in Q4. It is worth noting this was caused by higher supply from US production, OPEC being ineffective in cutting production, and watered down sanctions against Iran. The negative market sentiment that oil prices collapsing comes from slowing economic growth is mistaken, as global demand is forecasted to increase by 1.4 million BOE (IEA.org). Plus, lower oil price is a net benefit for the global economy.
Credit spreads widened dramatically in Q4. This indicator is critical for the pricing of corporate bonds and equities. Credit spreads should narrow as economic growth proves to be sustainable and the Fed follows through on their most recent comment about being willing to support the markets when in distress.
Emerging market debt, currencies, and equities were resistant to the 4th quarter sell-off. This is very positive as it signals that their economies are more stable than what was priced in earlier this year. Valuations are still the most attractive in this area of the market.
Growth in Europe downshifted in 2018. Investor sentiment is very depressed so any signs of improvement should propel the market higher. Household and corporate balance sheets are healthier than any time since 2008, they continue to have extreme monetary stimulus (low rates) and employment is expanding. Notwithstanding Brexit, the European economy should show signs of growth again which will surprise on the upside.
China is slowing as they make adjustments to a slower but more stable services and consumer based economy. Authorities have committed to fresh policy support if the economy continues to downshift caused by US tariffs, a housing slowdown or lower consumer spending. Chinese fiscal policy is powerful and similar to the “Fed Put”.
In Canada, GDP growth was decent in 2018 estimated to be 2.1%, but slowing to 1.7% in 2019 (per BOC forecast). Job growth is healthy but wage gains are disappointing. This is a reflection of poor job quality growth. There are opportunities in some areas within the Canadian market, but we remain underweight.
In summary, the fears of recession are overblown, markets are more reasonably priced and we expect a recovery and decent returns in 2019. The above factors parallel 2015’s market correction and economic slowdown, which led to above average returns in 2016 and 2017.