Not-So-Great Expectations: Will Market Struggles Continue This Year?

Is there a path upward for markets this year?

Much has been made in the news recently about the possible onset of the next recession - and rightfully so, in our opinion, as we believe the next economic downturn is a matter of when not if. In fact, we peg the odds of a U.S. recession by the end of 2020 at roughly 67%. In other words, a negative economic event looks increasingly likely to us in the not-too-distant future. Yet, in the short term, we think there’s a less than one-in-three draw—a 29% probability, per our Business Cycle Index (BCI) forecasting model—that a recession will hit in the next twelve months.

Therein lies the rub: An economic slump is probably on the way, but not imminently so. It’s no question that concern over when such a storm will hit shore contributed to much of the dizzying descent for markets last quarter—and while January kicked off the new year with meaningful gains, we don’t see volatility going away any time soon. That said, we do see a way forward through the gathering storm clouds—but it will likely require looking for opportunities outside the U.S.

U.S. forecast for 2019: A bumpy ride

Simply put, we expect U.S. equities to have their fair share of struggles in 2019—not unlike the fourth quarter of 2018 when America took the brunt of a plunging stock market. While weak performance was the name of the game across the board last October through December, U.S. markets sold off significantly more than their non-U.S. counterparts, especially in the emerging markets sector.1

Why? In our opinion, it all boiled down to valuations. U.S. equities, in our view, were extremely expensive heading into Q4—inflated by lofty expectations. By contrast, emerging market equities—while not wildly cheap—were nowhere near as costly, having already been beaten up by a host of monetary crises in places like Argentina and Turkey.  

Fast forward three months, and the picture still looks mostly the same to us today: Pricey U.S. equities, and comparatively cheaper options elsewhere—in spite of the broad market selloff. This, in our view, underscores just how extraordinarily expensive the U.S. market was during the bulk of 2018: Last quarter’s ugliness bumped U.S. equity valuations down to merely the really expensive range.

In short, because we still see valuations as quite high—just not stratospheric—we think that the troubles for U.S. stocks are far from over this year. That’s not to say that 2019 will play out to the same tune as last quarter—i.e., with stomach-churning drops and a narrow bear-market miss. However, we think movements in markets will largely be driven by whether or not expectations are met.

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These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

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