Outlook 2019: Climbing a Rockier Road

By: Kate Warne, Ph.D., CFA December 18, 2018

As we contemplate 2019, the road looks rockier with increased market volatility. Have we passed the peak of this expansion, or is there room left to climb?

Bumpier markets ahead

In Edward Jones’ view, the market is still climbing, but economic and earnings growth rates have peaked as the effects of the tax cuts and other one-time changes fade. As we move through the later stage:

  • Be prepared for frequent predictions about the end of the market cycle – such predictions are mostly wrong, but downturns can happen without warning.
  • Bumpier markets may be challenging – realistic expectations and a few adjustments can help keep you sure-footed.

Flatter yield curve

Edward Jones expects the Federal Reserve to continue slowly raising short-term interest rates, pausing during 2019 unless inflation rises well above its 2% target. Longer-term rates are also likely to increase slightly, which would keep the yield curve relatively flat.

A flat yield curve means the rate on short-term bonds is close to long-term bond rates without the additional interest rate risk, which is why Edward Jones recommends adding short-term CDs and intermediate-term bonds. A flat yield curve is generally consistent with modest economic growth ahead.*

Outlook for corporate earnings

Companies have begun to confront faster-rising costs and occasional shortages as overall wages rose by more than 3% and tariffs pushed prices up. While companies can pass these higher costs on to consumers, tough competition and disruptive competitors may impose limits, which would help keep inflation near the Federal Reserve’s 2% target. Edward Jones expects corporate earnings to decelerate from a rate above 20% growth in 2018 to less than 10% in 2019. That’s still strong enough to support higher stock prices over time.

Diversifying internationally

The synchronized upswing among global economies that took shape in 2017 stalled in 2018 as the European expansion waned and China’s growth continued to slow. We expect world GDP growth to fade a bit more in 2019, but recent indicators suggest Europe is finding its footing and China’s growth should stabilize as policymakers provide additional stimulus. In addition:

  • We don’t expect the U.S. dollar to rise as much in 2019 as it did this year, potentially improving prospects for some emerging markets and overall international performance.
  • International worries are likely to continue to prompt volatility, but we don’t think they’ll end the bull market.
  • The European Central Bank may begin to wind down its stimulus later in the year. Keep in mind that similar moves by the Fed in 2015 prompted short-term market anxiety.
  • U.S.-China trade tensions are unlikely to be resolved immediately. Although we don’t expect a full-blown trade war, lengthy negotiations mean additional volatility is likely.

We think investors have become overly pessimistic regarding international equities, and they are trading at sizable discounts to U.S. stocks. Reasonably positive fundamentals, mixed with policy and trade risks, support our expectation for better performance and our recommendation to diversify your investments internationally.

Realistic expectations

Your measure of success should be your progress toward your important long-term goals. If your portfolio lagged the market at times in 2018, you may want to reconsider how much risk you’re comfortable taking. Most investors don’t want to take on as much volatility as stocks offer.

Bonds can help reduce swings in portfolio values because their prices frequently move in the opposite direction from stocks, or fall less when both decline. But when stocks are rising, portfolios with bonds don’t perform as well as stocks alone. Better-diversified portfolios – including bonds, international stocks and smaller companies as well as large-cap U.S. stocks – can provide attractive returns with less portfolio volatility.

Your asset allocation – the mix of all those investments – is designed to help you stay invested when markets move sharply, which they can do from time to time. Remember that stocks fell by more than 10% twice during the past year, and that’s not unusual. Make sure you have realistic expectations for how market volatility can affect your portfolio. You may need to rebalance by adding fixed income and international equities to return it to the right mix of investments for your comfort with volatility, time horizon and goals.

Be prepared for rougher terrain

Stocks became more volatile in 2018 as investors reacted to a host of worries, including prospects for slowing global growth, higher interest rates, slower earnings growth and rising international tensions, as well as higher tariffs. Edward Jones doesn’t think any of those concerns will vanish in 2019, which is why we expect normal volatility to continue.

As long as the underlying fundamentals of economic and earnings growth remain positive, however, we believe pullbacks can be opportunities to add quality investments at lower prices. To help address higher market volatility, we recommend rebalancing your portfolio and improving its diversification. Consider:

  • Adding short- and intermediate-term investment-grade fixed-income investments to rebalance to the appropriate mix of stocks and bonds based on your comfort with risk and long-term goals.
  • Reviewing your immediate expenses so that you have enough cash to cover them short-term.
  • Adding small- and mid-cap U.S. stocks as well as large-cap stocks, which could benefit from solid earnings in 2019.
  • Adding international equity investments in developed and emerging markets. Political conflicts, slower economic growth and trade tensions have made investors pessimistic about international equities and reduced valuations, creating an attractive opportunity, especially if some of the growth and trade concerns are resolved more quickly than expected.

This cycle has been lengthy, and in our view, slower growth rates could help extend the later stages so they last longer than many expect. Don’t let a rockier road deter you from taking appropriate actions to help you toward your important long-term goals.

Important Information:

*Past performance is not a guarantee of what will happen in the future.

Investing in equities involves risks. The value of your shares will fluctuate, and you may lose principal. Small- and mid-cap stocks tend to be more volatile than large company stocks. Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

Diversification does not guarantee a profit or protect against loss in declining markets.

This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.

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