Economic & Market Outlook - First Quarter 2019

Executive Summary

Asset Class Returns – 2018 Review

The return environment in 2018 proved to be challenging, with most major asset classes posting losses for the year [Exhibit 1]. 2018 also saw the return of volatility, which had been at unusually low levels throughout much of 2016 and 2017. While returns were volatile during the first 3 quarters of the year, it was during the final quarter that volatility spiked higher and risk‐assets, such as equities, saw their weakest returns. The fourth quarter sell‐off brought the returns for most segments of the equity and fixed income markets into negative territory, giving back a portion of the strong gains that were achieved during 2017.

Economic Outlook

• Recent financial market volatility has contributed to concerns that a recession is imminent, but economic data do not support this conclusion.
• In 2019, we expect economic growth in the U.S. to moderate to a more sustainable pace of about 2% based on the continued positive impact from fiscal stimulus, deregulation, low unemployment and strong consumer and business confidence.
• Risks to this outlook include an escalation of trade tensions, a Fed policy mistake, a continuation of the slowdown in China, or an unexpected surge in inflation.

U.S. Equity Outlook

• With investor sentiment low heading into 2019, market participants will need evidence that the fundamental backdrop remains healthy. At year end, sentiment began to price in recession risk for 2020 with price to earnings ratios for the S&P 500 Index pushed down to nearly 14x 2019 expected earnings.
• While earnings growth will slow from the torrid pace of 2018, positive earnings growth in the range of 5% remains the most likely outcome for 2019.
• Upside potential to our base case of a 10% increase in equities may come from better than expected earnings, an end to the rate hike cycle or a positive resolution to the U.S./China trade war.
• Downside risks stem from a slowing global economy that leads to recessionary conditions in 2020. Causes may include restrictive monetary policy, an escalation of the trade war and slower global growth.

U.S. Fixed Income Outlook

• The Fed continued on its gradual pace of tightening in 2018, increasing the federal funds rate four times to 2.38%. Recent commentary indicates a pause in the rate hike cycle, which has led to a decline in interest rates.
• The 2018 increase in bond yields means higher potential bond returns in 2019. A diversified portfolio of investment grade bonds, as measured by the Bloomberg Barclays U.S. Aggregate Bond Index, now yields between 3 and 4%.
• While the yield curve has flattened, short‐term interest rates have risen faster than longer‐term interest rates, the curve remains positively sloped signaling that a recession is not likely in 2019.

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