Gathering Storm or Passing Clouds?

Key Points

  • The last couple of weeks has been a microcosm of 2018—higher volatility and more violent moves by stocks. Heading into 2019, we think we’ll see more of the same, with investor patience likely to be tested.

  • Economic growth is slowing, but not yet to the point of threatening a recession in the near term. Risks have risen, as evidenced by the flattening of the yield curve, with the Federal Reserve and trade relations with China holding near-term keys to both the degree of slowing and market volatility.

  • Uncertainty is high in the United Kingdom (UK) as the Brexit vote comes down to the wire, but it isn’t necessarily a binary outcome.

“If you want to see the sunshine, you have to weather the storm.”
Frank Lane


The past few weeks have been a fair representation of the majority of the year, with higher volatility, sharp moves on the down side (with sharp counter-trend rallies), a focus on the Fed and trade relations. Discipline and defense and have been warranted this year; and likely will again heading into next year. Starting late last year, we made several tactical recommendation changes which brought our overall global equity recommendation to slightly underweight—with a relative overweight to U.S. large cap stocks and a relative underweight to emerging markets (EM). This past August, we lowered our rating on the technology and financial sectors (from outperform to neutral) and raised our rating on the utilities and REITs sectors (from underperform to neutral); thereby leaving only healthcare with an outperform rating. With a corresponding underperform to communications services, our sector recommendations clearly have a defensive tilt.

We believe the second market correction this year, which has recently picked up steam, was largely brought on by three major worries: peak economic growth, Federal Reserve policy (and the related inversion of a portion of the yield curve), and trade/tariffs uncertainty. With regard to the first, the International Monetary Fund (IMF) recently downgraded its view of U.S. economic growth, with a projected 2.9% growth rate in 2018 decelerating to 2.5% in 2019; while the Bloomberg consensus has growth declining to 2% year/year by the end of 2019. We will likely arrive at next July with the expansion still ongoing, which would mean this would be the longest post-WWII expansion ever. However, the risk of recession is increasing and trade may hold a key to the length of runway between now and then. Concerns about a hawkish Federal Reserve eased somewhat last week after Fed Chairman Jerome Powell said rates were “just below” the Fed’s estimate of neutral, neither stimulating or restricting growth or inflation—a notable change from his comments in early–October, when he said that rates were “a long way” from neutral. As you can see in the chart below, following those recent comments from Powell, expectations for 2019 rate increases fell and now only one rate hike is expected next year.