INTRODUCTION
2018 has been a difficult year for investors as long
bull markets in both U.S. equities and fixed income
have encountered strong headwinds, and
international stocks have underperformed following
a very strong 2017. Shifting fundamentals in an
aging expansion have certainly played their part
in slowing investment returns, as the U.S. Federal
Reserve (Fed) has gradually tightened U.S.
monetary policy, a new populist government in
Italy has revived Eurozone fears and Middle East
turmoil has led to more volatile oil prices.
However, the single most important issue moving
global markets in 2018 was rising trade tensions,
and this will likely also be the case in 2019. In a
benign scenario, the U.S. and China come to an
agreement on trade issues, potentially allowing the
dollar to fall and emerging market (EM) stocks to
rebound following a very rocky 2018. In an
alternative scenario, an escalating trade war could
slow both the U.S. and global economies with
negative implications for global stocks.
While investors will likely focus attention on trade
tensions and other risks to the forecast, it is also
important to form a baseline view of the outlook.
And so in the pages that follow, we outline what we
believe is the most likely scenario for the
U.S. economy, fixed income, U.S. equities and the
global economy and markets. We also include a
section exploring some risks to the forecast and end
with a look at investing principles and how they can
help investors weather what could be a volatile year
ahead.
U.S. ECONOMICS: FINDING MORERUNWAY
Entering 2019, the U.S. economy looks remarkably healthy, with
a recent acceleration in economic growth, unemployment near a
50-year low and inflation still low and steady. Next July, the
expansion should enter its 11th year, making this the longest U.S.
expansion in over 150 years of recorded economic history.
However, a continued soft landing, in the form of a slower but
still steady non-inflationary expansion into 2020, will require
both luck and prudence from policy makers.
On growth, real GDP has accelerated in recent quarters and is
now tracking a roughly 3% year-over-year pace. However,
growth should slow in 2019 for four reasons:
First, the fiscal stimulus from tax cuts enacted late last
year will begin to fade. Under the crude assumption of an
immediate fiscal multiplier of 1, the stimulus from tax cuts
would have added 0.3% to economic activity in fiscal 2018
(which ran from October 2017 to September 2018), 1.3% in
fiscal 2019 and 1.1% in fiscal 2020. However, it is the
change in stimulus, rather than the level of stimulus that
impacts economic growth, so this tax cut would have
added 0.7% and 0.6% to the real GDP growth rate in the
current and last fiscal years, respectively, but should
actually subtract 0.1% from the GDP growth rate in the
next fiscal year.
Second, higher mortgage rates and a lack of pent-up
demand should continue to weigh on the very cyclical
auto and housing sectors.
Third, under our baseline assumptions, the trade conflict
with China worsens entering 2019 with a ratcheting up of
tariffs to 25% on USD 200 billion of U.S. goods. Even if the
conflict does not escalate further, higher tariffs would
likely hurt U.S. consumer spending and the uncertainty
surrounding trade could dampen investment spending.
Finally, a lack of workers could increasingly impede
economic activity. Over the next year, the Census Bureau
expects that the population aged 20 to 64 will rise by just
0.3%, a number that might even be optimistic given a
recent decline in immigration. With the unemployment
rate now well below 4.0%, a lack of available workers
may constrain economic activity, particularly in the
construction, retail, food services and hospitality
industries.
Under this scenario, the U.S. unemployment rate should fall
further. Real GDP growth impacts employment growth with
a lag, and a few more quarters of above-trend economic
growth could cut the unemployment rate to 3.2% by the
end of 2019, which would be the lowest rate since 1953.
However, we do not expect the unemployment rate to fall
much below that level,
as remaining unemployment at that point would largely
be non-cyclical.
2018 has been a difficult year for investors as long
bull markets in both U.S. equities and fixed income
have encountered strong headwinds, and
international stocks have underperformed following
a very strong 2017. Shifting fundamentals in an
aging expansion have certainly played their part
in slowing investment returns, as the U.S. Federal
Reserve (Fed) has gradually tightened U.S.
monetary policy, a new populist government in
Italy has revived Eurozone fears and Middle East
turmoil has led to more volatile oil prices.
However, the single most important issue moving
global markets in 2018 was rising trade tensions,
and this will likely also be the case in 2019. In a
benign scenario, the U.S. and China come to an
agreement on trade issues, potentially allowing the
dollar to fall and emerging market (EM) stocks to
rebound following a very rocky 2018. In an
alternative scenario, an escalating trade war could
slow both the U.S. and global economies with
negative implications for global stocks.
While investors will likely focus attention on trade
tensions and other risks to the forecast, it is also
important to form a baseline view of the outlook.
And so in the pages that follow, we outline what we
believe is the most likely scenario for the
U.S. economy, fixed income, U.S. equities and the
global economy and markets. We also include a
section exploring some risks to the forecast and end
with a look at investing principles and how they can
help investors weather what could be a volatile year
ahead.
U.S. ECONOMICS: FINDING MORERUNWAY
Entering 2019, the U.S. economy looks remarkably healthy, with
a recent acceleration in economic growth, unemployment near a
50-year low and inflation still low and steady. Next July, the
expansion should enter its 11th year, making this the longest U.S.
expansion in over 150 years of recorded economic history.
However, a continued soft landing, in the form of a slower but
still steady non-inflationary expansion into 2020, will require
both luck and prudence from policy makers.
On growth, real GDP has accelerated in recent quarters and is
now tracking a roughly 3% year-over-year pace. However,
growth should slow in 2019 for four reasons:
First, the fiscal stimulus from tax cuts enacted late last
year will begin to fade. Under the crude assumption of an
immediate fiscal multiplier of 1, the stimulus from tax cuts
would have added 0.3% to economic activity in fiscal 2018
(which ran from October 2017 to September 2018), 1.3% in
fiscal 2019 and 1.1% in fiscal 2020. However, it is the
change in stimulus, rather than the level of stimulus that
impacts economic growth, so this tax cut would have
added 0.7% and 0.6% to the real GDP growth rate in the
current and last fiscal years, respectively, but should
actually subtract 0.1% from the GDP growth rate in the
next fiscal year.
Second, higher mortgage rates and a lack of pent-up
demand should continue to weigh on the very cyclical
auto and housing sectors.
Third, under our baseline assumptions, the trade conflict
with China worsens entering 2019 with a ratcheting up of
tariffs to 25% on USD 200 billion of U.S. goods. Even if the
conflict does not escalate further, higher tariffs would
likely hurt U.S. consumer spending and the uncertainty
surrounding trade could dampen investment spending.
Finally, a lack of workers could increasingly impede
economic activity. Over the next year, the Census Bureau
expects that the population aged 20 to 64 will rise by just
0.3%, a number that might even be optimistic given a
recent decline in immigration. With the unemployment
rate now well below 4.0%, a lack of available workers
may constrain economic activity, particularly in the
construction, retail, food services and hospitality
industries.
Under this scenario, the U.S. unemployment rate should fall
further. Real GDP growth impacts employment growth with
a lag, and a few more quarters of above-trend economic
growth could cut the unemployment rate to 3.2% by the
end of 2019, which would be the lowest rate since 1953.
However, we do not expect the unemployment rate to fall
much below that level,
as remaining unemployment at that point would largely
be non-cyclical.
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