Here we are, with 2018 in the rearview mirror and a fresh, new year ahead. Overall, the past year was a frustrating one for investors — volatility returned after a calm 2017, generating two corrections, one of which took the market down more than 20 percent on an intraday level, briefly putting us into bear market territory. No one could blame you if you felt like most asset classes are headed for a negative year in 2019 after an unsettling December. But let’s not throw in the towel just yet.
My firm, Capital Investment Advisors (CIA), has identified a handful of key themes that we feel will likely dictate the market’s direction in 2019. Here is how we expect those topics to play out, and what they may mean for the economy and the markets.
The result: The Dow Jones Industrial Average (Dow) has finished up in the third year of a president’s first term in all but one instance in the past eight decades. (The one-off dip happened at the outset of World War II in 1939, when the Dow dropped 0.1 percent.) President Donald Trump’s quest for a second term may guide him toward resolution on the most significant thorn in the economy’s side — the trade issue.
The state of the economy: Heading into 2019, there are few signs of recession. The data simply doesn’t support the thesis that the “R-word” is imminent this year.
Perhaps the most telling economic data set — the Leading Indicator Index (or “LEI”) — is still indicating more than 5 percent growth. As context, during the past 60 years, we haven’t had a recession until the LEI has turned negative.
Still, if there is one snag in the fabric of continued economic growth, it’s the trade issue with China. Investors rightly fear the impact of a full-blown trade war could wreak havoc on markets and global growth. We estimate that such a development could create an additional $250 billion headwind to U.S. GDP in 2019 alone. But the Trump administration is also keenly aware of this looming threat and seems poised to resolve the dispute (at least in the near term) over the coming year. To reiterate, a slowing economy isn’t a boon for re-election.
Another trend that cuts in favor of a strong U.S. economy in 2019 could be sustained lower oil prices. Oil is now hovering below $50 a barrel after peaking at over $75 this past summer. With our level of petroleum consumption in the U.S., a discount like this on crude oil alone could produce a 0.5 percent rise in U.S. GDP.
Interest rates: The Federal Reserve knows that interest rates can’t be blindly raised into perpetuity. Currently, we seem very close to a “neutral rate,” where rates have been ratcheted up enough from zero that they are no longer fueling nor slamming the brakes on economic growth. In their last meeting of 2018, the Fed indicated that 2019 growth would moderate, not fall, and hinted at a slower rate of rate hikes.
The current correction: When will it end? No one knows for sure. But we do know that market downdrafts tend to be much less severe when not accompanied by a recession. Data shows that the average non-recession correction is in the 17 to 20 percent range, versus the 35 percent range of corrections with recession. Other economic data isn’t indicating an imminent recession, so it appears that this correction is of the more mellow variety.
One critical event that generally occurs at a market bottom is what’s called a “washout.” The volatility index (VIX) — the market’s fear gauge — historically has been a good predictor of washouts because we see panic selling. We’re not there yet; while elevated, key levels haven’t been breached to date. So, unfortunately there’s likely more pain to endure before we hit bottom.
The stock market: Our current outlook may be best described as a stumble followed by a jump. The stumble is the corrective phase we’re navigating now, and the jump is a prospective recovery in early or mid-2019.
If the economy continues to hold its own (as we anticipate) and the trade fight comes to resolution (or at least less saber rattling), investors will likely refocus on reasonable earnings growth. With this new outlook, investors could find a stock market with strong company fundamentals and attractive valuations. And, back to presidential history, the average return for the S&P 500 during the third year of terms has been over 20 percent. Of course, history is only a guide, but it should at least provide a tailwind to U.S. equities in 2019.
On the international front: After a healthy 2017, international equities stubbed their toe during 2018. As always, there are countless factors at work, but two primary reasons include slower economic growth and a strong U.S. dollar.
The net result: Global equities now trade at approximately 75 percent of U.S. valuations, and yield roughly 70 percent more. Given this stark underperformance over the past decade (roughly 200 percent less return), and coupled with the fact that many foreign nations are following our lead from 2017 and enacting financial stimuli of their own in 2019, we could see international markets rebound during the new year.
The “quick fix” of cannabis: The cryptocurrency boom has subsided, leaving get-rich-quick investors looking for their next “sure thing.” Enter cannabis.
We could see an explosion of new companies spawned by the slow-but-sure legalization of marijuana. We’ve all heard the stories of small cannabis shops experiencing 1000 percent sales gains. And it’s true; some have. But lost in the discussion is that many pot dispensaries have declined over 50 percent from their sales peaks.
As far as manias go, we see legalized marijuana as more likely than cryptocurrencies to become an ongoing industry with real growth potential. But there’s a big caveat to our support of the marijuana sector. We like to focus on companies with strong cash flows that can withstand various economic conditions. Many small cannabis companies trade at nosebleed valuations despite little revenue and cash flow. (It’s a bit reminiscent of the dot-com bubble.) So, we’d prefer to focus on large, established companies that may benefit from the trend as one part of their business, as opposed to companies with all their eggs in the marijuana basket.
Bottom line for 2019
Capital Investment Advisors believes 2019 will bring a less hostile Federal Reserve along with some sort of near-term trade resolution. Add in the impact of lower oil prices, and the economic expansion we have seen for nearly 10 years could have more runway. Lower oil prices, coupled with clarity on trade and a more patient Fed, should go a long way in allowing the market to break out of the doldrums for brighter days.
The original AJC article appears here.
This information is provided to you as a resource for informational purposes only and should not be viewed as investment advice or recommendations. Investing involves risk, including the possible loss of principal. There is no guarantee offered that investment return, yield, or performance will be achieved. There will be periods of performance fluctuations, including periods of negative returns. Past performance is not indicative of future results when considering any investment vehicle. This information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. Always consult your own legal, tax, or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.