Out with the Old, in with the New
Calmer markets prevailed on Monday to conclude a year in which investors realized losses in equities for the first time in 10 years. Volatility mostly absent from markets the year before came back with a vengeance in 2018, particularly in the fourth quarter. As the chart below demonstrates, equities from small cap to large in both foreign and domestic markets retrenched last year, while investment-grade bonds fought back to end the year with close to flat returns. Oil got hammered and Bitcoin plunged.
Growth in GDP and earnings won’t match the levels experienced in 2018, but we see forward progress on both counts. Benefiting from last year’s tax cuts and abundant jobs, the U.S. consumer is key to driving an ongoing economic expansion that we see becoming the longest ever this summer. While incremental stimulus from the 2017 Tax Cuts and Jobs Act will be less impactful this year, reduced tax burdens at both the consumer and corporate level should help to further boost consumption spending and investment.
Investors fear the Fed will go too far in raising rates. But with little evidence that moderate wage growth is translating into faster rates of inflation, the Central Bank can be increasingly judicious in moving rates further above the targeted level of inflation. Indeed, this is just the commentary from Fed Chair Powell today that helped rally markets to finish the week.
Economic growth remains intact. We see 2.5 percent GDP growth in 2019 and, against this backdrop, corporate earnings stand to grow at mid-single digit rates this year. Bottom line … we see a more challenging late-cycle economic environment having already trimmed equity valuations, increasing the odds that earnings growth translates into commensurate levels of equity appreciation in 2019.
The Seat Belt Sign is On
Nevertheless, 2019 is off to a turbulent start. The first couple trading days of the year were the worst in 18 years, only to be eclipsed by a huge rally today that left equity investors a bit richer for the week, albeit whipsawed in the process. Weaker global manufacturing reports and news of Apple’s first revenue warning in 15 years catalyzed losses that put the plane into a dive, but investors found smoother air in hints of a less aggressive Fed. While Chinese data from December indicated contraction in manufacturing, the equivalent report from U.S. manufacturers confirms ongoing growth at a slower rate. When including services, both of the world’s largest economies remain in growth mode … to the title of this piece.
Today’s robust U.S. labor report, a 312,000 surge in nonfarm payrolls accompanied by sub-4 percent unemployment, emphasizes the health of the all-important consumer. Meanwhile, Apple has issues that are only partly explained by slowing growth in China, namely high-priced phones that aren’t selling as well in lower income emerging markets. To contrast with Apple’s experience of late, Nike recently reported accelerating sales growth in China.
Week in Review and Our Takeaways
Volatility continues into 2019, with stocks swinging dramatically in a holiday-shortened week
We envision a constructive, though volatile, backdrop for stocks and foresee positive equity returns for the year