We identify three new market themes and update our asset views for 2019. We see growth in the global economy and corporate earnings slowing, and expect the Federal Reserve to become more data dependent in increasing rates. For investors, greater uncertainty calls for balancing risk and reward.
We expect global growth to slow next year, and see U.S. growth stabilizing at a much higher level than other regions, even as the effects of 2018’s fiscal stimulus fade. Markets are vulnerable to fears that a downturn is near, even as we see the actual risk of a U.S. recession as low in 2019. Global earnings growth is also set to moderate in 2019, tracking the more subdued growth outlook.
Kate Moore :
The first theme of our 2019 outlook is growth slowdown. But let’s be clear, we’re talking about a slowdown in the pace of economic growth, not necessarily an end to the expansion. In fact, we see the global economic expansion continuing not just through 2019, but into 2020. This is also important because in the beginning of 2018, we were really featuring a view of sustained and synchronized expansion. But in the year ahead, we expect the growth rate of different regions and countries to vary meaningfully. This will lead to investment opportunities and significant implications for risk assets across all different regions. We also talk about a slowdown in the pace of earnings growth in 2019, and just with economic growth, we would also want to point out that this is a slowdown in the pace but not actually an end to what we expect to be a sustained earnings expansion over the years ahead. So what are the investment implications? In a world where growth is slowing down but still expanding, and where earnings growth is going to be lower than it was in 2018, we think investors need to be much more differentiated and tactical in their portfolios than they were earlier in the cycle. This leads to opportunities in different regions and sectors. Our two favorite regions based on both economic growth and earnings growth are the US and emerging markets led by China. We think both have adjusted to changes in policy over the course of the year, and are well-positioned to outperform over the year ahead.
We see the process of tighter financial conditions pushing yields up (and valuations down) set to ease in 2019. Why? U.S. rates are en route to neutral — the level at which monetary policy neither stimulates nor restricts growth. We estimate the current neutral rate at around 3.5%, right in the middle of the 2.5%-to-3.5% long-term range identified by the Fed. Yet we expect the Fed to pause its quarterly pace of hikes amid slowing growth and inflation in 2019.
Terry Simpson :
Our second theme for the year ahead outlook is nearing neutral. It is true that the Federal Reserve is nearing its neutral rate that is a rate that neither stimulates nor restricts economic growth. But by our estimates, we still believe the Federal Reserve is well below the level of the neutral rate in the economy. It’s also true though that financial conditions are tightening. We have to understand the Federal Reserve has been raising interest rates since 2015, as well as continuing to normalizing their balance sheets. Now by our gauge, we do see financial conditions tighter, but we also say they’re still relatively loose. Now across the oceans, we still see the European Central Bank, as well as the Bank of Japan, still being very far off form fully normalizing monetary policy.
Balancing risk and reward
Increasing uncertainty – primarily about the impact of rising trade conflicts – points to the need for quality assets in portfolios. But building more resilient portfolios is about more than just dialing down risk, as overly defensive positioning can undermine investors’ long-term goals. We advocate exposures to government bonds as a portfolio buffer, flanked by high-conviction allocations in areas that offer attractive compensation for the risk.
Terry Simpson :
So our third theme we’ve labeled Balancing Risk and Reward. In 2018, what we saw was that uncertainty explained a greater portion of risk asset returns. So what should we do to mitigate that uncertainty in portfolios? One of the things we thought about at BlackRock is advising our clients to be building resilient portfolios. But building resilient portfolios is not just about dialing risk down. Because having too defensive of a position in your portfolio can actually offset some of your strategic goals. What we advocate is a barbell approach. On one end, core exposures to defensive assets such as short-term U.S. treasuries, which are attractive given the level of yield, as well as quality equities and/or the quality factor. On the other end of that barbell approach, we have to think about risk assets that should benefit should we see a reduction of uncertainty as well as a reduction in trade tensions, i.e., these assets that basically offer attractive risk premia given the decline that we’ve seen in 2018. So it’s about a barbell approach as we look into 2019 to mitigate some of the uncertainty that we think about for portfolios.
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Elga Bartsch/Head of Economic and Markets Research
Isabelle Mateos y Lago/Chief Multi-Asset Strategist
Kate Moore/Chief Equity Strategist