Outlook

By Guest Blogger Ryan Lewenza

Who’s with me when I say that I’m happy to close the books on 2018 and looking forward to 2019? 2018 was a total stinker of a year for investment returns. The S&P 500 essentially endured a stealth bear market in Q4, having declined nearly 20% peak-to-trough. The TSX and international markets also sucked wind, but I think the weakness in 2018 could be setting us up for a decent 2019. Let me explain.

As covered in recent blog posts I attribute last year’s volatility to the Fed continuing to hike interest rates, Trump’s trade war with China and his impulsive actions in Q4 (e.g., attacks on Fed Chairman Powell, the rash decision to withdraw from Syria leading to the resignation of his Defense Secretary, and his bonehead move to shut down the US government over his wall funding that’s never coming), and concerns over a slowdown in the US/global economy. Critically, I see some of these headwinds reversing in 2019.

After hiking rates four times last year the Fed is likely to slow the pace of further rate hikes in 2019. Inflation remains well contained and economic growth should slow this year supporting a less aggressive monetary approach. As such, the Fed is expected to hike rates only 1-2 times this year, which we believe is the correct path.

On the US trade front, currently US and Chinese trade negotiators are trying to hash out a new trade deal, which would see China buy more US goods and address US concerns over China’s unfair business practices (e.g, intellectual property theft, and forced technology transfer for US companies doing business in China). I think it’s going to be a bumpy ride with occasional setbacks but I am hopeful that a deal will be consummated this year.

One key reason why I’m optimistic about a positive outcome is that Trump is obsessed with the stock market (and Fox News) and views it as a barometer of his presidential success. He’s starting to realize that his tough approach on China is weighing on the stock market and I believe this will drive him to finalize a trade deal with China. As he said this week, the December market decline was a “glitch” and “it’s going to go up once we settle trade issues.”

So, from my perspective the two biggest headwinds in 2018 could turn to tailwinds for 2019.

Next up is the economic outlook, which we remain optimistic on heading into the New Year. The equity markets acted as if we were on the precipice of a global recession in Q4, and we just don’t see it for 2019. Sure the US economy is likely to slow from the roughly 3% growth seen in 2018, as the fiscal stimulus (tax cuts and increased government spending) rolls off, but we see the US economy still growing at a decent 2-2.5% in 2019. As seen below, China is expected to slow from 6.5% to 6.2%, and the overall global economy is expected to slow from 3.7% to 3.5% this year, based on consensus estimates. Does this sound like a major contraction/recession in the global economy?

Forecasted GDP Growth Rates for 2019

Source: Bloomberg, Turner Investments

This is critically important since most bear markets are brought on by a US/global recession, which is not in the cards for 2019.

Against this economic backdrop the outlook for corporate earnings remains encouraging. US, Canada, and global earnings are expected to grow by single-digits this year. Sure this is a noticeable deceleration from 2018, when US earnings grew at over 20%, but positive earnings growth is still very supportive to stock prices heading into 2019.

Earnings Outlook Remains Positive

Source: Bloomberg, Turner Investments

Lastly, for the first time in some years stock valuations are looking attractive. As seen below the US markets now trade at 16x earnings (down from 20x last January), which is in-line with their long-term average. Canadian and international stocks are outright cheap trading at roughly 13x. In fact, Canadian stocks are trading at near their lowest levels in history relative to US stocks. Given these cheaper valuations and similar earnings growth rates to US stocks, we see international stocks outperforming US stocks in 2019.

Equity Valuations Are Attractive

Source: Bloomberg, Turner Investments

To recap, I see very low odds of a recession, decent earnings growth and attractive valuations – not a bad fundamental backdrop for 2019.

What could go wrong? In a word…Trump.

I see two major Trump risks for 2019. First, is the ongoing trade deal with China. He could, on a dime, change his view and listen more to his trade hawks (Peter Navarro and Robert Lighthizer) and decide to scuttle the trade deal and follow through with his threats to increase tariffs on Chinese exports. Second, is a potentially damaging report from Mueller leading to the Dems initiating impeachment proceedings. I hope this doesn’t occur as this would be negative for the stock market in the short-term, and that’s what elections are for. If they want him out, leave it to the voters in 2020.

As we saw this week, following the disappointing revenue guidance from Apple, equity markets are likely to remain volatile this year. However, when all is said in done, I believe markets will post stronger results in 2019 as investors realize the global economy is not falling off a cliff and the major headwinds in 2018 (Fed rate hikes and Trump’s trade war) will turn out to be important tailwinds for the markets in 2019.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.