At Parametric we’re always examining the past to understand the lessons we can take away from it. However, we also appreciate that markets are ruthlessly forward looking. For that reason, we also consider what may lie ahead.
Our purpose in putting this market outlook together isn’t to reflect a “house view” in our investment strategies. We’re humble enough to understand that annual financial forecasts are fraught with error, so our investment strategies aren’t built with the expectation that we can accurately forecast the near term. Rather, our goal is simply to better understand the range of likely outcomes that investors can expect in the coming year—and to help them prepare for any given market scenario.
Of course, as we go through this exercise, it would be foolish to ignore the elephant in the room. US equity markets are coming off a very weak fourth quarter—one that saw the S&P 500® Index shed 13.52% of its value. No doubt the heightened volatility led to a lot of sleepless nights for investors, advisors, and market observers over the holiday season. So now seems like a particularly opportune time to discuss what may lie ahead in 2019—in other words, what figures to continue keeping us up at night.
Trade wars: It’s not just China
When it comes to trade, the relationship between the US and China is an area of particular concern. The world’s two largest economies appear headed for an escalation of trade tensions that will most likely negatively affect growth around the globe. But China isn’t the only issue.
As the International Monetary Fund noted in October, there are multiple challenges to growth around the globe, including rising trade barriers that are disrupting the supply chains that have stimulated global growth over the past decade. Trade barriers not only affect the price consumers pay for goods but also have the potential to limit business expenditures, which has longer-term economic impact.
Brexit, which challenges the free flow of goods, services, capital, and labor across European Union borders, is just one example. Trade tensions are also simmering between the US and the EU, and the NAFTA replacement agreement informally agreed to by the US, Mexico, and Canada—a rare positive outcome in an otherwise troubling environment—still has some important details to be worked out before it’s officially ratified.
As the chart below illustrates, it’s difficult to overstate how important trade has become to global growth. Which leaves investors to wonder how disruptive continued trade conflicts can become.
Sources: World Bank, Deutsche Bank Global Research, October 2018
Fed up: the end of quantitative easing and low interest rates
For nearly the past decade, monetary authorities around the globe have undertaken aggressive measures to stimulate economic growth. The US Federal Reserve, for example, grew the size of its balance sheet in the years after the Global Financial Crisis to encourage investors to purchase stocks, bonds, and other risk assets. But the tide of quantitative easing is ebbing, and 2019 will see it ebb even further.
The European Central Bank announced it would be ending asset purchases in December 2018. And as the chart below shows, the Fed has begun shrinking its balance sheet by allowing Treasuries and mortgage securities to mature and not replacing them. Since it started doing so at the end of 2017, the Fed’s balance sheet has declined from approximately $4.5 trillion to $4.0 trillion.
Sources: Federal Reserve Economic Data, Federal Reserve Bank of St. Louis
It makes sense that if quantitative easing was good for risk assets, then its reversal presents a headwind for them. And that’s not the only stumbling block markets may have to overcome: The Fed has raised interest rates by 0.25% nine times since December 2015, most recently just before the Christmas holiday. While rates aren’t expected to rise in such rapid succession in 2019, it seems clear that the era of extremely low rates is behind us.
Everything else that’s keeping us awake
Trade and monetary policy may be two of the biggest challenges ahead, but there are a host of others. For example, as the stimulus from tax cuts in the US fades, will we realize it was simply a temporary sugar high? Will anti-Europe or Euro-skeptic forces gain ground in European elections in the coming year and accelerate fragmentation? Will the US government become further mired in gridlock as Democrats assume control of the House? Will the US address large structural deficits to build a cushion of protection against a future downturn? Or does a split government make that outcome less likely?
The bottom line
It’s only natural to ask: Is there anything we can actually look forward to in 2019? The answer is a resounding yes—all the challenges described above provide an opportunity for good news. Markets have a built-in expectation for how these issues will be resolved. To the extent resolution happens in a more favorable manner than expected, investors are likely to be rewarded. For example, if China and the US resolve their trade dispute in a timely fashion, equity markets would likely rally. Therefore, the challenge for investors is determining how the year ahead will unfold relative to the expectations already in place.
That ultimately means learning to accept uncertainty. And the best way to deal with ongoing uncertainty in financial markets is to check your emotions at the door and stick to the well-thought-out investment plan you’ve built—the one that acknowledges that markets will rise and fall and that reacting rashly to either scenario isn’t a likely path to success, or to a good night’s sleep.
A Custom Core® SMA allows investors to take charge of their passive mandates. Portfolios are held as separate accounts, giving investors the ability to customize them to their needs. Investors can select from a wide range of benchmarks and then tailor their exposure to incorporate their unique objectives.
Tom Lee, CFA, Chief Investment Officer, Equities and Derivatives
Tom leads Parametric’s Research, Strategy, Portfolio Management, and Trading teams, coordinating resources, aligning priorities, and establishing processes for achieving clients' investment objectives. Tom has coauthored articles on topics ranging from liability-driven investing to the volatility risk premium. He is a voting member of all the firm's investment committees. Prior to joining Parametric in 1994 (originally as an employee of the Clifton Group, which was acquired by Parametric in 2012), Tom spent two years working for the Board of Governors of the Federal Reserve in Washington, DC. He earned a BS in economics and an MBA in finance from the University of Minnesota. A CFA charterholder, Tom is a member of the CFA Society of Minnesota.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.