We anticipate bumpy times for equities in 2019. A combination of economic, geopolitical and policy factors have already reduced price/earnings multiples by near record amounts. We have dialed down risk in 2018 and will likely continue to do so in 2019 as we expect global growth to slow. However, the expected volatility could cause dislocations that are not fundamentally driven, resulting in tactical opportunities to consider.

Volatility expected

We have lowered earnings expectations globally due to more subdued revenue and margin assumptions. We believe investors will be confronted by increased volatility amid slower global economic growth, trade tensions and changing Federal Reserve policy. Our base case relies on the view that the U.S. may enter a recession in 2020. As the market dropped 9% in December, the worst market return in any 4th quarter post World War II, many risks are starting to be discounted by the market. We have reduced industrials, basic materials and financials due to heightened risks.

There are a number of factors that are driving this view, but it is important to note that risks to the upside do exist:

  • The Fed: The Fed’s slow pace of hiking interest rates is meant to be just enough to keep wage inflation from accelerating, but not so much that it crushes business and consumer spending. It’s a difficult balancing act.
  • Fiscal stimulus: The tightening of fiscal conditions has already created a slowdown that only time and lower rates will heal. The impact from the U.S. government’s lower tax rates and higher spend will end when 2019 does.
  • Trade and China: The lack of clarity on trade has created an “uncertainty tax,” forcing companies to seek alternative means of procurement, adding to inefficiencies and holding back some investment decisions. China is trying to stimulate its consumer sector, but the country is already weighed down by high debt and defaults, and it has limited ability to create demand at present.
  • European politics: Brexit negotiations and Italy’s budget situation have added to the political fog affecting investor confidence.

So what do you do?

Don’t “run for the hills”, but do be prudent. In uncertain markets like these, we look to do three things: reduce risk, focus on high quality and stay alert for opportunities due to dislocations.

  1. Since mid-2018 we have dialed back risk and will likely continue to do so in 2019. We have shifted allocations from cyclical to secular exposures. We have reduced industrials, basic materials, semiconductors and financials due to heightened risks. As the year turns, we are removing our recommendation of small caps as well. 
  2. We continue to target high-quality companies with secular growth opportunities that can generate dividends as well as capital appreciation. Two sectors stand out as both strategically and tactically attractive.  Aging demographics and rapidly improving technology are paving the way for robust growth potential in Healthcare. Accelerating growth in data, and the need to transmit, protect, and analyze it ever more quickly, make certain areas in Technology an attractive secular opportunity as well.
  3. Where possible, we advise investors to maintain a tactical portion of their risk assets, because volatility may give them the opportunity to find mispriced sectors, themes and individual securities.

Still, in this climate, the bottom line is that you should be increasingly mindful of risk in your portfolio so that you can reach your long-term investment goals. For more information, we encourage you to reach out to your advisor.