2019 Outlook

2018 – Looking back briefly
The U.S. economy maintained solid growth throughout 2018, reflected in high levels of consumer optimism. Simultaneously, trade tensions with China and tightening monetary policies contributed to thundering volatility in the fourth quarter.

Throughout 2018, investors found they could no longer rely on the Federal Reserve Bank to provide accommodative policies that pushed up riskier asset classes like equities (the so-called “Fed put”). As the Fed moved towards monetary policy normalization, investors worried about the consequences of such actions. Market gyrations and equity volatility left investors few asset classes to allocate to that did not incur losses (see Figure 1). The 90-day trade armistice, which began Jan. 1, will likely provide a period of relief in the short-term.

2019 – Looking ahead
The economy is moving into its late-cycle phase and most economists expect a slowdown. The key question will be how far the current economic momentum carries into 2019 before the slowing begins. Key factors include the outcome of trade wars, when the Fed ends normalization policies, and what surprises will come out of the Washington gridlock.
Trade War – China and the United States

Our changing relations with China go beyond trade issues and the uncertainty of the changes resulted in unanticipated economic events. Presidents Trump and Xi agreed to a new round of trade negotiations but headlines from these negotiations will continue to create market volatility.
Both Trump and Xi need to settle for individual reasons – Trump needs to improve his chances for re-election and Xi needs to reenergize a slowing economy. If a Cold War truly develops between the U.S. and China, investors will be facing many more unknowns.

Figure 2
China Activity is Softening

The Fed – Normalization
Investors were reminded of the complex results that occur when the Federal Open Market Committee (FOMC) tightens policies that simultaneously increase the Fed Fund rates and reduce the size of its balance sheet. With the Fed Funds rate increases approaching the 2.5% to 3.5% estimated range for the so-called “neutral rate”, the FOMC faces the difficult decision of when to end rate increases. The Fed Funds futures suggest there is a low probability of an increase in 2019 and looking even further into 2020, the Fed Funds market curve calls for a lower Fed Funds rate. Comparatively, the FOMC looks for two increases in 2019 and one in 2020. How soon we begin to feel the bite of the tightening policies will determine when the economic slowing begins; however, financial markets are already showing scars from that bite.

Figure 3

Political Confidence and Investment Impact
Financial markets require political confidence beyond the usual investor focus on the economic and investment outlook. Without speculating on the impact Russian meddling played in the U.S. elections, no doubt it undermined America’s confidence in the political process. It will take more time to reestablish such political confidence and this will prove particularly troublesome if we suffer from an economic slowdown, in part, related to the forces of populism.
The year 2019 begins the campaign efforts by multiple candidates for the Democratic presidential nomination. The apparent swing of the Democratic Party to the left could easily result in a Democratic populist candidate for President in 2020. If successful, ironically, a left-wing populist President would replace a populist of the right. This result would likely produce a significant change for both economic policies and therefore, financial markets.

Figure 4

Investment Conclusions

The extreme volatility in the financial markets may lead investors away from a sound disciplined financial approach to investing. In our view, using a diversified, disciplined approach remains the best strategy to reach investors goals despite the current higher market volatility. This includes a prudent portfolio mix of equities, alternatives, and fixed income securities. This diversified mix should be adjusted based upon long-term fundamental changes that would affect your diversified asset mix.

Points to Consider When Reviewing Markets and Allocating Asset Classes:
Key Macro Points:
• Economic growth will likely slow in the second half of 2018
• Presidential election cycle positioning will impact domestic policy and likely include surprises regarding trade and infrastructure
• Monetary policy will likely get closer to “normalization” and potentially reverse
Key Asset Allocation Points
• Higher quality U.S. equities with growth prospects (and not too expensive) remain attractive
• International equities remain neutral but provide attractive valuations
• Longer duration fixed income and corporate credit remain unattractive
• Stress will likely increase in various corporate credit segments
• Liquid and private alternatives remain attractive, particularly as traditional fixed income struggles to provide diversification similar to past periods

The information contained herein has been compiled from sources deemed reliable and it is accurate to the best of our knowledge and belief. However, SkyView Investment Advisors, LLC cannot guarantee its accuracy, completeness, and validity and cannot be held liable for any errors or omissions.