The fourth quarter of 2018 and its aftermath in 2019 will likely be talked about for years to come. The reason comes down to math: If you sold after the S&P 500’s 13.5% fourth-quarter decline, you would have missed out on the subsequent 18.5% recovery through June. Similar to past market swings (e.g., late 2015 and early 2018), this brings to mind the enduring wisdom that overreacting to current volatility can be detrimental to long-term investment health. By the same token, staying invested consistent with individual goals and risk tolerance, while engaging where feasible in portfolio “tilts” to capitalize on short-term market conditions, can provide a solid foundation for portfolio growth potential.
The first-half market turn was especially remarkable given that the current U.S. economic cycle recently became the longest in modern history—over 10 years starting in mid-2009. How much further can it go? That’s the object of considerable debate. Recent pressures include a slowing global economy and U.S.-China trade tensions, which at times have dominated market sentiment. Corporate earnings, supported by the 2017 stimulus for much of last year, look to be in the low single digits for 2019. Meanwhile, the inverted yield curve, although imperfect in projecting recessions, is reflecting the bond market’s economic pessimism.
That said, this year’s equity rally has largely been about policy rates, and the Federal Reserve may be entering a phase of rate reductions designed to offset trade hazards—something that for now could help risk assets, particularly “high-beta” stocks like small caps that stand to benefit from overall market strength as well as non-U.S. equities, which have recently trailed U.S. counterparts.
More broadly, it’s worth considering how the current stage in the economic expansion may affect market opportunities and risks. In this edition of Investment Quarterly, our cover story provides three ideas on approaching late-cycle investing. Other topics include yield benefits of preferred securities, Fed policy choices and U.S.-China trade dynamics, as well as a midyear update on our “Ten for 2019” investment outlook. On the planning front, we look at saving for education and establishing domicile. I hope you enjoy this issue of IQ.
On a final note, I am pleased to welcome Stephanie Luedke, who recently joined the firm as Head of Private Wealth Management. Stephanie will guide the strategic integration of broader investment choices and expanded wealth management services—part of our ongoing efforts to meet the evolving needs of our clients.
As always, please do not hesitate to contact your Neuberger Berman team with any questions about the markets or your portfolio.
From the Asset Allocation Committee
U.S. Equities: Given higher valuations and slow earnings growth, we have a neutral 12-month outlook on U.S. equities, with an underweight view of large caps. However, we see potential opportunity in small-cap stocks, especially if Federal Reserve easing combines with improving economic data later in the year.
Developed Non-U.S. Equities: Although employment, credit growth and consumer confidence are encouraging, global trade tensions have weighed heavily on the European manufacturing sector. The Japanese economy remains sensitive to global dynamics, while a consumption tax increase may dampen growth in the short term.
Fixed income: Despite the Fed’s easing bias, we maintain an underweight view in investment grade yields, while after a strong rally municipal valuations are tight in our view versus comparable Treasuries. TIPS (Treasury Inflation-Protected Securities) look attractive to us in relation to inflation potential; high yield and floating-rate loans are providing pockets of opportunity.
Emerging Markets: Dollar weakness from looser Fed policy could support emerging markets, particularly equities, where we maintain an overweight outlook. Stimulus-driven improvement in China’s economic growth could also prove supportive, although trade tensions remain a risk.
Alternatives: With increasing asset class correlations, we have a neutral view on low-volatility hedge funds, but maintain an overweight outlook on directional hedge funds, favoring market (or beta) exposure within hedging assets. In our view, although private equity appears fully valued, it retains appeal as a strategic allocation to generate differentiated returns.
Commodities: Oil producers are adhering to production limits, but how long they last is an open question. Demand for oil could slow if global growth remains subdued or U.S.-China trade tensions worsen.