For 2019, What to Expect in a Turbulent World: More Trouble

Art by David Flaherty

Strategists from a quintet of leading investment firms—JP Morgan, Invesco, Charles Schwab, Russell, and Vanguard—predict that no recession is imminent, although we will have to traverse a lot of trouble.

In a troubled 2018, the stock market suffered two corrections (more than 10% down from the recent peak), amid rising geopolitical tensions and a tightening of Federal Reserve monetary policy. Although we aren’t at the historic bull run’s completion, these worrisome forces and more are at work.

In 2019, investors are wary of slowing economic growth, and cautious to move in areas such as China. But they do take heart at Fed Chairman Jerome Powell’s assertion that the central bank will be “patient” about further interest rate hikes. That implies there’s still room for the market to run for now.

While forecasts vary from institution to institution, these are some of the opinions we’re seeing from investment professionals:

Economic Expansion Will Slow, but the Trade War Ends

Growth is predicted to slow due to uncertainty surrounding world policies as well as the end of the tax cut-driven euphoria impacts, which propped up businesses in 2018.

If the leaders of the two largest economic powers, Donald Trump and Xi Jinping, are to settle their differences, Chinese stocks will rise. If not, the current slump in Chinese stocks likely will worsen. As a result, at some point the US, and possibly the rest of the world, will start feeling a sting from the aftermath as well, if Apple and Ford’s trade-related woes are any indicator.

For investors, the task is to determine if China’s long-enviable growth rate will keep going, or whether they should cut their losses and allocate to more attractive emerging markets. That includes India, which is loosening its bureaucracy and foreign trade policies, and Brazil, which is excited about the chances of its new president, Jair Bolsonaro, making good on his promises.

Dubravko Lakos-Bujas, JP Morgan’s head of US equity strategy, thinks the markets will be just fine, and that it is more likely we will see a resolution between the two leaders. In a research note, he wrote: “Based on our probability-weighted analysis of US-China trade outcomes (55% trade deal, 35% cease-fire, 10% tariff escalation), we set our 2019 S&P 500 price target to 3,100 and earnings per share estimate at $178.”

Vanguard sees a grimmer scenario, with a 53% chance of escalation that will harm the global economy, trimming between 30 and 50 basis points from growth rates. It also sees an 18% chance of the trade war going off the rails. Vanguard says there’s a 29% chance that the dispute between the US and China will end in 2019.

The overall consensus was that the US tax cuts propped up earnings growth in 2018. Since a newer tax reduction won’t be happening in 2019, earnings may weaken. “On the fiscal policy front, we may continue to see the expansionary effects of the Tax Cuts and Jobs Act through the first part of the year,” Vanguard said in its 2019 outlook, which expects a “soft landing” for the US. “However, we expect the boost to the year-over-year GDP growth rates from consumer spending to begin fading away toward the second half.”

Brexit a Bust 

The Eurozone and the effects of Brexit will also slow growth overseas. The European Central Bank is expected to start cooling off its quantitative easing program from last year’s end, which could add more disruption in the region’s bond markets. There is also a worry that a more hawkish type could take over from Mario Draghi’s seat as the bank’s president. Invesco says that might create more volatility in both the Eurozone’s stock and bond markets.

Brexit has been difficult, and with the EU’s deadline approaching in March, expect a shake-up one way or another. JP Morgan estimates a 10% chance no deal takes place in the first half of 2019 and a 40% chance that Brexit won’t happen at all. With the recent events of a no-confidence vote leading UK Prime Minister Theresa May and her government to call for a plan B, this is a growing possibility.

Vanguard sees the Bank of England making two interest rate hikes (one in May, the other in November) if its “Compromise Brexit” base case pans out. The firm thinks no deal could present the bank an opportunity to reassess its inflation outlook, but a chance exists it could still raise rates anyway.

How Many Times Will the Fed Hike?

While Chairman Powell has said the year features fewer interest rate hikes and that he will take a “wait-and-see” approach, investors will be leery over whether that will prove true. Although markets could, and probably will, rise over the months prior to an increase, the bulls might not be as optimistic as last time. Volatility threw many an investor for a loop, and they won’t want something similar one year later.

Schwab thinks Powell will raise rates two to three times, and could either pause or end the hikes altogether by midyear. Vanguard says it will happen only once, and JP Morgan is betting on three.

Russell Investments, however, thinks we could get four. The firm also does not think the markets have yet peaked, as they have never peaked more than 13 months before an economic recession. Volatility will still occur throughout the year, Russell believes. Emerging markets economies are tightening in line with the Fed’s actions, which also harms the overall environment.

The 10-year Treasury bond attained a peak at the 3.25% level it reached last October, before retreating, according to Schwab. As the Fed slims its balance sheet, there may be some volatility in riskier fixed-income areas such as bank loans, high-yield, and emerging market bonds, by Schwab’s reckoning. Municipal bonds, which don’t have as robust a market and don’t trade as much, should be fine, Schwab says. The yield curve is also expected to flatten as short- and long-term interest rates converge.

Last Call for Bulls

Although a small chances of a recession exists, most investors aren’t expecting to see one until 2020. The cycle is reaching an end, and we should be experiencing the end shortly, strategists say. Forecasts haven’t done a full 180 from 2018’s optimism, but they are hardly upbeat.

The liquidity tide is heading out, and stealth bear markets could pop up during the year. Market volatility will continue, but its unsure if it will be as rough as 2018. JP Morgan says the markets will continue to grow, as Lakos-Bujas called 2018’s volatility a third reset, behind the intra-cycle resets of 2011 and 2015.