As we look forward into 2019, we believe there is continued potential for positive US equity returns, but slowing economic growth may mean more frequent downhills — and more investors losing their way — than during the market’s climb of recent years. Observing the weight of the evidence, we have moved into a late-cycle environment. In our view, the path forward will not rely on choosing growth versus value, or small-cap versus large-cap. We believe it will rely on identifying “share takers” (companies that can gain market share from technology-enabled advantages in their business model and in consumer behavior) and avoiding “share losers” (companies that have simply been buoyed in recent years by the expanding economic environment).
Late cycle, but maybe longer cycle too
While we are late in the cycle, economic data has continued to look positive and we are not seeing imminent signs of a downturn. The gloomy macro headlines of late 2018 are not materially different from those that we saw earlier in this nine-year run, and yet US stocks are up over 400% since March 2009.¹ In fact, the economy remains quite healthy, and if historical precedent holds up, there is still room to be positive on equities as we move into 2019 and on to early 2020. The previous two secular bull markets (1942-1966 and 1982-2000) lasted 18 and 24 years respectively, and delivered over 1000% returns off the prior market lows.²
Slowing growth and the biggest risk we see today
Our base case expectation is for slowing growth over the next 12 to 18 months. The positive benefits of US tax stimulus and deregulation are being offset by higher interest rates, rising labor costs and trade pressures. While we see a natural deceleration in growth, we do not believe recession is imminent.
The biggest risk to this view is a misstep in Federal Reserve (Fed) monetary policy. Today, we believe the Fed is walking a knife’s edge: It is balancing expected economic data and the inertia of its telegraphed rate path against the unknowable impacts of tax reform benefits and the lagged impact of relatively quick successive rate hikes. If the Fed tightens too quickly, higher interest expense could drive corporate earnings growth lower and possibly drive the economy into a recession by materially increasing business and personal financing costs, at the same time that cyclical growth is naturally slowing.
1 Source: Bloomberg L.P., based on cumulative returns for the S&P 500 Index as of Sept. 30, 2018
2 Source: Bloomberg L.P., based on cumulative returns for the S&P 500 Index