2019 Economic & Market Outlook
- Expect global economic growth to continue albeit at a more modest pace.
- Anticipate monetary policy tightening globally to pause against a backdrop of low inflation and decelerating growth.
- Foresee positive returns for equity and bond investments in 2019.
Global Economic Growth
Since the last recession, which was the result of the bursting of the housing bubble and the ensuing financial crisis, the global economy has grown steadily, save weakness outside of the United States resulting from the European sovereign debt crisis in 2011. Accommodative monetary policy has supported this growth, and yielded improvements in employment and production globally. In addition, despite the infusion of liquidity, inflation has been muted, which has allowed central bank policy to keep rates lower for longer. Admittedly, the global economy was given a dose of adrenaline in the form of the stimulative tax cuts passed by Congress in late 2017, and that has likely extended the current economic cycle. With that said, we believe that the recent softening in economic data globally should not be attributed entirely to the overhang of tariffs and recent market volatility.
Global measures of manufacturing in the form of PMIs (Purchasing Managers’ Indexes) have indicated that new orders, production, and employment measures have come down from their cycle highs, and although still expansionary, these measures have pointed to a lower pace of growth in the coming months. Leading economic indicators are still trending higher, but are also pointing to slower growth in 2019, particularly as we move into the second half of the year. In addition, while strong jobs data buoyed markets to begin 2019, the unemployment rate is considered by economists to be a lagging indicator, and therefore the strong positive print provides little support for growth. The one area of the economy that points most strongly towards growth is the consumer. Consumption has driven the economic growth we have experienced over the past decade, and with wages rising, the consumer should remain engaged. Consumer debt has increased over the past several years, but the levels are still lower than what was facing consumers during the financial crisis. Retail sales are strong, and consumer confidence remains close to historical highs. Therefore, while we admit that the growth experienced in 2018 is likely to moderate this year, we believe there is enough support currently to indicate that a recession will not occur in 2019.
Monetary Policy Tightening
As mentioned above, the policy of global central banks over the last decade has been accommodative, and has resulted in interest rates remaining low for much longer than was initially expected. While there have been some fits and starts with tightening after the process began here in the U.S. in 2015, there has been increased consternation around the Fed’s interest rate hikes over the past several months. The rationale espoused by critics of the Fed’s plan to continue raising rates is that with inflation far from threatening to push the economy into an overheated condition, additional rate hikes are unnecessary. Indeed, the reasoning behind raising interest rates, particularly in a programmatic fashion, is to slow the economy and curb inflation. The challenge for the Fed in the current scenario is that the interest rate hikes have been necessary to move the economy out of a zero interest rate environment, rather than to ease the effects of overheating. This will then allow the Fed the latitude to cut rates and stimulate the economy when we enter the next recession. However, the recent volatility in the equity markets, along with a smattering of softer economic data releases, has put immense pressure on the Fed to adjust its plans to increase rates this year, and we believe that a pause will be the result.
Outside of the United States, there is even less appetite to tighten policy. The European Central Bank’s bond buying program ended in December, and yet the economy is no stronger than it was at the beginning of 2018, with inflation still well below target. The Bank of England raised rates twice, however, uncertainty around the outcome of the Brexit negotiations has halted that progress. Finally, the Bank of Japan and the People’s Bank of China appear more than content to keep monetary policy loose for the foreseeable future.
Equity and Fixed Income Value
With the economy growing and monetary policy fairly loose, we expect the macroeconomic environment to remain supportive of risk assets in 2019. In our view, we expect equities to earn mid single digit returns for the year.
Following the declines of the fourth quarter of 2018, valuations are more attractive, and there are areas of the market which no longer appear overvalued. From a positioning standpoint, we favor large cap equities over small cap equities, both in the U.S. and in the developed international markets. We believe that volatility is likely to persist, and typically small cap equities underperform late in the cycle and during periods of volatility. Small cap stocks had performed well on the back of the corporate tax cut, but we believe this effect will wane. As for emerging markets equities, we have maintained a neutral stance for much of the last two years, but we acknowledge that there are some particular tailwinds which could boost performance this year – namely, a resolution of the tariff issues, and a stable U.S. dollar.
Within fixed income, given our expectation for a pause by the Fed, we expect low single digit returns for investment grade debt – both taxable and municipal issues. We remain underweight within the asset class to begin the year, but we are likely to move towards a neutral position as we move through 2019. High yield bonds have performed well over the last several years, save the fourth quarter weakness. However, we acknowledge that as we move later in the cycle, the risk represented by investing in these lower quality issues is likely not worth the incremental yield; as such, we may move to an underweight should the economy show signs of deterioration. Finally, we expect to increase our allocations to strategies which offer a differentiated source of risk and return. While strategies focused on minimizing exposure to equity risk have underperformed over the last several years, we expect these strategies to provide a diversification benefit over the next several years.
How Boston Private can help
We encourage you to reach out to your Wealth Advisor here at Boston Private Wealth for a deeper discussion on any of the above points, or to review your current plan, in order to ensure that it is still aligned with your long term goals.