As we are approaching the start of 2019, we could identify five important tailwinds and an equal number of headwinds going into play in the new year. Overall, we believe – at this stage – that the tailwinds will prevail.
Let’s start then with the tailwinds. The first one that we expect to continue uplifting the equities markets is the healthy earnings growth rate. The earnings growth rate may not be to the tune of 16%+ but it could well be between 9-12%, which certainly boosts the bottom line and keeps oiling the economic growth rate while also supporting incomes, spending, and business sentiment. The lower growth rate in earnings expectations has already started to be incorporated into the discounting of future earnings, and hence any positive surprises will be a further boost to the equities markets. The economy is not overheating, orders are continuing to grow, wage and income growth are healthy enough to keep supporting consumer spending, and financing is expected to remain available for the great majority of credit needs.
The second tailwind we see positively affecting the markets is the lower value of the dollar against other developed markets’ currencies (DM) as well as emerging markets’ currencies (EM), especially in the second half of 2019. We anticipate that the interest rate differentials will narrow, and a convergence of inflation rates will take place. As the dollar loses some ground, US exports will rise, repatriated profits (at lower USD valuation) will boost the bottom line even higher, while US assets (including financial assets) will become more attractive to foreigners.
The third tailwind has to do with the Fed and the tightening cycle. We are of the opinion that the Fed will tone down both its rhetoric as well as the number of times that rates will be raised in 2019. The US cannot afford high interest rates due to the ballooning deficit which adds significantly to the already unsustainable rate of debt growth. Moreover, the headwinds – see sections below – and other factors facing the US and the global economy (slower growth rate, debt unaffordability, lack of overheating, stabilizing unemployment rate) will act as a brake in the tightening cycle.
The fourth factor is related to trade disputes. We believe that both the rhetoric as well as the practice of higher tariffs will be toned down, and thus higher trade volumes, let alone predictability and higher stability, will affect positively both the top and the bottom lines, while also affecting the fifth factor in this initial assessment which is none other than the growth rate outside the US.
The fifth important factor that we see affecting positively the equities outlook for 2019 is the growth rate outside the US. We expect fewer tremors in emerging markets and a smooth transition in both the Brexit negotiations (in the case of a second referendum we may even see the remain vote to carry the day) as well as in the Italian saga. Furthermore, we expect that China will be transitioning into its slower growth in a manner consistent with expansionary fiscal and monetary policy.
And now here are some of the headwinds that the global economy is facing as we are approaching the gates of 2019:
The first one is related to Brexit, Italy, and the dysfunctional EU in general. It cannot be assumed that the Eurocrats and the Brexiters operate under rational expectations. Furthermore, bureaucratic reactions to reasonable proposals (such as lowering corporate tax rates in Italy) may inflict further damage to potential resolutions and compromises. Therefore, a messy Brexit and/or an Italian turmoil could not only upset EU markets but could also inflict unnecessary downgrading of expectations that could derail growth prospects.
The second headwind deals with China. Liquidity is tight in China nowadays. Growth is slowing down significantly, while non-performing loans are piling up in a country where debt (as a fraction of GDP) is the highest in the world. The opaque nature of that debt in combination with additional tariffs and a trade war with the US could create significant market turmoil where investors will be seeking the safety of bonds and of precious metals while dumping equities.
The third headwind is more geopolitical rather than economic/financial and has to do with Saudi Arabia and Iran. We cannot preclude that the internal issues that both countries are facing will not result in a search for diversion and a scapegoat, and given their proxy wars in Yemen and Syria – as well as their respective interests and positions in the rest of the Gulf countries – we can foresee a potential war between the two that will unsettle the energy markets, pull the US into it, and unravel all expectations regarding 2019.
The fourth headwind relates to a much-higher-than-expected slowdown in the growth rate of earnings and of GDP. If such scenario materializes, then a bear equities market will dominate possibly all of 2019 with high-multiple sectors suffering significant losses of more than 30% from current levels.
Finally, the fifth headwind is the unknown one: A development (such as political turmoil in the US, or a Lehman day for India) which, while underrated now, could dominate the headlines for months to come, derail new capital investments, and trigger a domino effect producing bear markets and other unforeseen consequences.
As a closing statement, allow us to reiterate that as we weight the tailwinds and the headwinds, we believe that the tailwinds will prevail.
Headwinds vs. Tailwinds: An Initial Assessment of Undercurrent Trends Affecting the Market Outlook for 2019
Author : John E. Charalambakis
Date : November 20, 2018
As we are approaching the start of 2019, we could identify five important tailwinds and an equal number of headwinds going into play in the new year. Overall, we believe – at this stage – that the tailwinds will prevail.
Let’s start then with the tailwinds. The first one that we expect to continue uplifting the equities markets is the healthy earnings growth rate. The earnings growth rate may not be to the tune of 16%+ but it could well be between 9-12%, which certainly boosts the bottom line and keeps oiling the economic growth rate while also supporting incomes, spending, and business sentiment. The lower growth rate in earnings expectations has already started to be incorporated into the discounting of future earnings, and hence any positive surprises will be a further boost to the equities markets. The economy is not overheating, orders are continuing to grow, wage and income growth are healthy enough to keep supporting consumer spending, and financing is expected to remain available for the great majority of credit needs.
The second tailwind we see positively affecting the markets is the lower value of the dollar against other developed markets’ currencies (DM) as well as emerging markets’ currencies (EM), especially in the second half of 2019. We anticipate that the interest rate differentials will narrow, and a convergence of inflation rates will take place. As the dollar loses some ground, US exports will rise, repatriated profits (at lower USD valuation) will boost the bottom line even higher, while US assets (including financial assets) will become more attractive to foreigners.
The third tailwind has to do with the Fed and the tightening cycle. We are of the opinion that the Fed will tone down both its rhetoric as well as the number of times that rates will be raised in 2019. The US cannot afford high interest rates due to the ballooning deficit which adds significantly to the already unsustainable rate of debt growth. Moreover, the headwinds – see sections below – and other factors facing the US and the global economy (slower growth rate, debt unaffordability, lack of overheating, stabilizing unemployment rate) will act as a brake in the tightening cycle.
The fourth factor is related to trade disputes. We believe that both the rhetoric as well as the practice of higher tariffs will be toned down, and thus higher trade volumes, let alone predictability and higher stability, will affect positively both the top and the bottom lines, while also affecting the fifth factor in this initial assessment which is none other than the growth rate outside the US.
The fifth important factor that we see affecting positively the equities outlook for 2019 is the growth rate outside the US. We expect fewer tremors in emerging markets and a smooth transition in both the Brexit negotiations (in the case of a second referendum we may even see the remain vote to carry the day) as well as in the Italian saga. Furthermore, we expect that China will be transitioning into its slower growth in a manner consistent with expansionary fiscal and monetary policy.
And now here are some of the headwinds that the global economy is facing as we are approaching the gates of 2019:
The first one is related to Brexit, Italy, and the dysfunctional EU in general. It cannot be assumed that the Eurocrats and the Brexiters operate under rational expectations. Furthermore, bureaucratic reactions to reasonable proposals (such as lowering corporate tax rates in Italy) may inflict further damage to potential resolutions and compromises. Therefore, a messy Brexit and/or an Italian turmoil could not only upset EU markets but could also inflict unnecessary downgrading of expectations that could derail growth prospects.
The second headwind deals with China. Liquidity is tight in China nowadays. Growth is slowing down significantly, while non-performing loans are piling up in a country where debt (as a fraction of GDP) is the highest in the world. The opaque nature of that debt in combination with additional tariffs and a trade war with the US could create significant market turmoil where investors will be seeking the safety of bonds and of precious metals while dumping equities.
The third headwind is more geopolitical rather than economic/financial and has to do with Saudi Arabia and Iran. We cannot preclude that the internal issues that both countries are facing will not result in a search for diversion and a scapegoat, and given their proxy wars in Yemen and Syria – as well as their respective interests and positions in the rest of the Gulf countries – we can foresee a potential war between the two that will unsettle the energy markets, pull the US into it, and unravel all expectations regarding 2019.
The fourth headwind relates to a much-higher-than-expected slowdown in the growth rate of earnings and of GDP. If such scenario materializes, then a bear equities market will dominate possibly all of 2019 with high-multiple sectors suffering significant losses of more than 30% from current levels.
Finally, the fifth headwind is the unknown one: A development (such as political turmoil in the US, or a Lehman day for India) which, while underrated now, could dominate the headlines for months to come, derail new capital investments, and trigger a domino effect producing bear markets and other unforeseen consequences.
As a closing statement, allow us to reiterate that as we weight the tailwinds and the headwinds, we believe that the tailwinds will prevail.