U.S. to Continue Late-Stage Expansion into 2019
AAM's Take:
As a whole, 2018 made up for 2017’s lack of volatility.
Investors reacted to tax reform, fiery trade discord, mid-term elections, rising interest rates and multiple natural disasters. Not surprisingly, the U.S. equity markets experienced dramatic swings throughout the year, hitting new highs in January 2018 before giving back more than their year-to-date gains by year-end.
Emotions can skew investor sentiment, to the point of overlooking economic fundamentals. Which is why, despite the “noise”, we believe that the U.S. will continue its late-stage expansion into 2019. That said, it’s critical to be vigilant in monitoring changing conditions that could potentially propel a recession.
What supports our expectations for continued economic growth in 2019?
the fundamentals:
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Although the Federal Reserve’s attempt to balance raising rates with supporting economic growth will be a challenging task, we expect the U.S. economy should be able to absorb
the anemic pace of rate increases (relative to previous cycles). Globally, we also expect to see
a rebound in both Europe and Emerging Markets believing the new trade agreements with Mexico and Canada are more indicative of the likely resolution to the current trade skirmishes, particularly with China.
Gross Domestic Product (GDP) Improvement
Labor Market Strength
Strong U.S. Consumers and Businesses
Deregulation
Corporate Earnings Growth
History as a Guide
Gross Domestic Product (GDP) Improvement
Labor Market Strength
Strong U.S. Consumers and Businesses
Deregulation
Corporate Earnings Growth
History as a Guide
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1985-1989
1990-1994
1995-1999
2000-2004
2005-2009
2010-2014
2015-2018
0.00
2.00
4.00
6.00
8.00
10.00
12.00
Federal Funds Target Rates
Source: Bloomberg
Gross Domestic Product (GDP) Improvement
The U.S. economy has now added jobs for nearly eight straight years. Continuing jobless claims hit a level not seen since 1970 and average hourly earnings rose to levels not seen since 2009. What’s more, the unemployment rate remained at 3.7% percent in November, the lowest in nearly 50 years.
Labor Market Strength
1990
$20,000 bln
$40,000 bln
$60,000 bln
$80,000 bln
$100,000 bln
Consumer and small business owner sentiment numbers remained high, as has the Conference Board Consumer Confidence Index.
We expect U.S. consumer spending will continue to be supported by consumers’ strong balance sheets and income statements—net worth and cash deposits are at all-time high levels and the debt-to-assets ratio has declined dramatically since the 2009 peak.
Household Net Worth and Cash Deposits
Source: Fed Flow of Funds
Strong U.S. Consumers and Businesses
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Current
$4,500 bln
$6,500 bln
$8,500 bln
$10,500 bln
$12,500 bln
Net Worth Outstanding right axis, $100,768 bln
Cash Deposits; $11,657 bln
2.9
2018 Estimated
%
2.5
%
2017
1.9
%
2016
2.0
%
2015
AAM's Top Themes for 2019
the forecast:
Favor Late-stage
Investments
Expect Healthy Rebound in Emerging Markets
Emphasis On
Commodity Sector
Expect Pressure on the U.S. Dollar
with the Chinese Yuan as the Wild Card
see all 9 of AAm's themes for 2019
Potential Risks to Our 2019 Outlook
the hazards:
Increased inflationary and wage pressures
force the Federal Reserve to be hawkish beyond current market expectations in normalizing monetary policy.
Accelerating consumer debt obligation ratios
beyond past historic stress levels may cause increased defaults and delinquencies.
Shifting political and economic policies
within the European Union move beyond a controlled evolution and fracture several EU economies
Ratcheted tensions between the U.S. and China
spiral to an actual trade war where global growth
decelerates and internal price pressures advance.
Earlier-than-expected downgrading of corporate investments
due to increased financial tensions, which prematurely advances the liquidity strains that occur during the end of every cycle.
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Important Disclosures
We expect Emerging Markets (EM) to bounce back, particularly Asia, though still favor some broad-based exposure. We generally favor EM equities rather than debt though select debt may generate strong performance.
We continue to gravitate toward the commodity sector, specifically Energy and Industrial Metals, as these areas tend to perform well during periods of inflation. The pressure that has pushed agricultural commodities lower may have some strong relative outperformance at points in 2019.
Increasing domestic budget deficits and a prolonged global economic recovery will likely pressure the U.S. dollar in the second half of 2019. We see gains in the euro, the pound, and a slight gain in the yen. The wild card is the Chinese yuan, whose direction will likely be determined by how quickly and to what degree trade tensions are resolved.
We’re bullish on late-stage cycle investments with an emphasis on Financials, Energy, Basic Materials, Consumer Discretionary and Industrials.
Deregulation holds the potential to extend what has already been an historic expansion. It generally requires several years of continued deregulation to influence business owners to
invest in their business versus meeting increased regulatory requirements.
In the four-year period following consistent reduction in regulations, GDP increased
to 4.3% annually, well-above the average over the last four decades.
Deregulation
For investors who want more than market fundamentals, we can look to history to better understand our current recovery. While recession lengths before and after the Great Depression were similar in length, the expansions were strikingly different:
Expansions prior to the Great Depression—the closest comparison to the Great Recession of 2007-09—lasted only 25 months on average, while the two following lasted 65 months on average.
History as a Guide
Earnings margins in 2018 have improved, albeit partially due to tax reform and the repatriation of U.S. dollars held abroad, both of which served to increase earnings per share (EPS) from a synthetic level. Expectations are for single-digit earnings growth in 2019 given more difficult year-over-year earnings comparisons, however we still expect it to remain above average.
S&P 500 Profit and Operating Margin
Source: Bloomberg, S&P
Historical
Average
Profit Margin
Corporate Earnings Growth
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Business cycle reference dates
duration in months
peak
Trough
contraction
Expansion
cycle
August 1918
march 1919
7
44
51
67
january 1920
july 1921
18
10
28
17
may 1923
july 1924
14
22
36
40
october 1926
November 1927
13
27
40
41
may 1937
june 1938
13
50
63
93
February 1945
october 1945
8
80
88
93
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Name
Email
State
Peak to Trough
Previous trough
to this Peak
Trough from
Previous Trough
Peak from
Previous Peak
This commentary is provided for informational purposes only. The indexes referenced in this publication are not available for direct investment. It is not an offer or solicitation of an offer to buy or sell any product or service. Unless otherwise stated, all information and opinions contained in this publication were produced by Advisors Asset Management, Inc. (AAM) and other sources believed by AAM to be accurate and reliable. Due to rapidly changing market conditions and the complexity of investment decisions, supple-mental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are as of December 7, 2018 and are subject to change without notice.
All AAM employees, including research associates, receive compensation that is based in part upon the overall performance of the firm. AAM may make a market in or have other financial interests in any given sector or security with which this analysis suggests may be benefited from its conclusions. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Past performance does not guarantee future performance.
Chart/Graph Disclosure: The charts/graphs included in this publication do not reflect past or current recommendations made by AAM, “they” should be considered an academic treatment of empirical data and should not be used to predict security prices or market levels. Any suggestion of cause and effect or of the predictability of economic cycles or investment cycles is unintentional. The Best Ideas for 2019 was created using empirical research and analysis by highly experienced market observers and is designed for educational purposes only. This publication should only be considered as a tool in any broker’s, dealer’s or advisor’s investment decision matrix. Investors should consult their financial advisor when applying the assumptions of these charts/graphs.
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Periods Pre-
Great Depression
Periods Post-
Great Depression
Avg Expansion : 25 Months
Avg Expansion : 65 Months
Operating Margin
Now
6.70%
Historical
Average
Now
9.86%
11.64%
13.36%
Annual GDP Growth
Historical Average: 1990-2018
Source: National Bureau Economic Research. Past performance does not guarantee future results.
Source: National Bureau Economic Research. Past performance does not guarantee future results.
Source: National Bureau Economic Research. Past performance does not guarantee future results