It could be more of the same. Our base case is a continuing state of “uneasy equilibrium,” where positive fundamentals, in the form of solid economic and corporate earnings growth, square off against rising macroeconomic uncertainty. Overall, our expectation is still that the environment for risk assets will be positive, but only mildly so: the economic cycle is getting long in the tooth and financial vulnerabilities are growing.
Key to those vulnerabilities are rising economic uncertainty, driven largely by trade disputes, and tightening financial conditions, driven by monetary policy that’s slouching towards neutral. For 2019, we believe global growth looks poised to slow along with corporate earnings growth, as the U.S. economy hits late-cycle. There doesn’t seem much chance of a recession in 2019, yet fear of recession might be a bigger factor, and could hit risk assets while supporting bonds. Vulnerabilities that have built over the past decade could shorten the cycle – or aggravate a downturn, should one occur – especially as financial conditions tighten. In the U.S., which has been leading developed economies in rate normalization, financial conditions are still not restrictive, though we believe the policy rate is approaching neutral. That has heightened uncertainty over the Federal Reserve in 2019.
For fixed income investors, that could mean (another) choppy year in 2019. How to respond? In general, cash and cash-like instruments might come in handy in the event of selloffs, while investors are getting paid more handsomely for short-duration debt. On the other hand, if there are more equity swoons, long bonds may provide a buffer.
In an uncertain environment, resilience is key. That doesn’t mean just reducing risk. It also means maintaining an agile stance, responding to opportunities – and threats – as they arise.