Equity Investment Outlook - April 2019

by John Osterweis of Osterweis Capital Management, 4/22/19

After suffering a tumultuous fourth quarter last year, the stock market rebounded nicely in the first quarter of 2019. Fears of an economic slowdown, escalating trade wars and monetary tightening gave way to optimism over continued economic expansion, low unemployment, a trade deal with China and a recognition that the Federal Reserve (the “Fed”) was pretty much done with its tightening cycle. The rally stalled a bit in March following Fed Chairman Powell’s remarks about a possible slowdown in the economy, but by then the markets had already posted substantial gains driven by strong earnings.

Moreover, parts of the yield curve again inverted, a “true” sign of impending recession. The real truth is that the yield curve has a habit of inverting more often than the economy has of going into recession. While there is no question the world faces a broad-based global slowdown, we think the U.S. economy should continue growing at a moderate pace with inflation well in check. The Fed has a dual mandate of (1) maintaining full employment and (2) stabilizing prices (i.e., low inflation). Since inflation is at or below the Fed’s target of 2%, we expect the Fed to be focused on maintaining full employment. Conclusion: a partially inverted yield curve in a low-interest rate environment does not necessarily indicate impending recession. Central banks around the world are running very accommodative policies, and underlying economic activity continues to be healthy, albeit moderating.

Our forecast, therefore, is that we will continue to be in a slow growth environment with moderate inflation. This has been the theme ever since the great financial crisis of 2008. We remain cautious given the extended duration of our economic recovery. As such, we continue to focus our investments in companies that are enjoying strong secular tailwinds, that have strong balance sheets and relatively low leverage, that have significant competitive advantages (often called moats), and that can experience accelerating earnings and cash flow growth. These are the same themes we have discussed in previous Outlooks.

Going forward, the stock market may well experience some volatility as investors vacillate in their collective assessment of economic growth, inflation, interest rates and the political landscape. And, of course, there is some risk of an earnings recession as opposed to a general economic recession. But to the extent we own companies with steady or improving earnings and cash flows, we expect to be well served over time. To give you a sense of what we mean, please review the following case study of Brookfield Asset Management, a company that embodies all the themes we think are important at this time.