The stock market's bull run stumbled late last year in response to proliferating risks ranging from rising interest rates and trade tensions to geopolitical issues such as Brexit. By the time 2018 ended, the S&P 500 was down 6.2% on the year and 14.7% off the record high it posted in October.
The worries that derailed the rally last year are still clouding the horizon in 2019 and promise to fuel continued market volatility. Despite those risks, the U.S. economy should keep chugging along, although at a slower rate, said Rob Sharps, head of investments at T. Rowe Price. He noted that while the U.S. is in the later stages of the business cycle, he doesn't see a recession this year.
If stocks have stopped heading higher in lockstep, perhaps stock picking will come back into vogue. Jerome Dodson, chairman of Parnassas, said that when he's looking for investment ideas, he checks out the stocks that were hit hardest the previous year. He pointed to semiconductor capital equipment and health care as two sectors that look promising going forward.
Kyle Weaver, portfolio manager at Fidelity, says the key is identifying the business models that will benefit most from such secular trends as e-commerce and vaping.
Amy Zhang, portfolio manager at Alger, argued that small caps are the place to be given higher interest rates, trade friction and economic growth that is expected to be moderate. She said investors should look for innovative companies, because firms that have the potential to transform and disrupt the industry they're in have the best chance of delivering strong performance.
Bold prediction for 2019: GE's business stabilizes, and its stock begins a comeback. 2019 is the first year in a dramatic turnaround that leads to several years of outperformance under new leadership.
Disruption in its various forms —notably technological and political — combined with an aging economic expansion will likely drive global financial markets in the coming year.
Our investment professionals have identified five themes that they believe will play out in 2019 and beyond:
• U.S. economic and corporate earnings growth will slow markedly from recent levels.
• Several geopolitical risks will sustain market volatility.
• The next recession is not likely in 2019.
• Rising risk premiums, especially in emerging markets, are creating attractive opportunities for long-term investors.
• About a third of the S&P 500 market — measured by market capitalization and revenue — is being challenged by some level of secular disruption.
With the U.S. moving into the later stages of the business cycle, the U.S. Federal Reserve raising interest rates, and monetary and credit conditions diverging widely across the other major global economies, the potential for sustained volatility in both equity and fixed-income markets remains high. However, we believe a global recession remains a relatively modest risk in 2019 despite the age of the economic expansion.
(More: Bob Doll's 2019 predictions)
Political risks are adding to the uncertainty. These include the deepening trade dispute between the U.S. and China, rising tension with Saudi Arabia, the Mueller investigation and renewed fiscal conflict between Italy's populist government and European Union officials.
Additionally, the global corporate landscape continues to be transformed by a combination of technological innovation and changing consumer preferences, which is upending many established business models.
Although disruption and cyclical factors create risk, they can also generate opportunities for investors. Many of these concerns are increasingly reflected in asset prices.
Bold prediction for 2019: The stock market will snap out of its slump next year and be up over 15%, as the U.S. economy picks up steam.
At our firm, we do deep fundamental research on stocks, using macro conditions only as a backdrop. We find value one security at a time and, when we find companies trading at least a third off their intrinsic value, we might buy them.
So, it's not surprising that my best ideas usually come from looking at what stocks dropped the most during the previous year. If a company's balance sheet is still strong and its long-term business prospects are still good, then it could be a buy.
Right now, I like semiconductor capital equipment stocks like Lam Research (down 26% to $139) and Applied Materials (down 36% to $34). This sector is very volatile right now, but prospects should improve in 2019, which should make for a strong recovery.
Health care is another area where stocks have dropped more than warranted. Gilead Sciences is down 9% to $67 and Celgene is down 34% to $70. These are both good companies with lots of cash and offer innovative science. The bears are concerned that some of their medicines are no longer growing. However, if they develop a new product or use their cash to buy one, these stocks will climb much higher.
Another interesting investment is NVIDIA (down 24% to $147). A drop in the price of bitcoin and other cryptocurrencies along with a shift toward alternative technologies reduced the demand for the company's products that were used in mining the currencies. The stock should come back as the demand for graphics processing units (GPUs) accelerates from gaming, artificial intelligence in data centers and self-driving vehicles.
Finally, another stock with good potential is Apple. This is a stock down only 1% since the start of the year, but it's down 28% to $166 from its high of $232 on Oct. 3. Demand for iPhones is no longer growing as it once was, but people are still buying them and demand for their other services, like pay, cloud and music, is gaining strength.
Bold prediction for 2019: High valuations mean both over the long term investors should expect subdued equity returns, and over the short term, the odds of a market correction are as high as 1:2 at any point in time over the next three years.
As we approach 2019, our investment outlook for the global capital markets remains guarded, and we can expect to continue to see returns well below historical norms. Since the trough in equity markets nearly 9½ years ago, investors have benefitted from exceptional returns — 14.2% annualized for global equities. This strong performance has pushed valuations much higher, signifying a more subdued outlook for global equities going forward.
Based off Vanguard's Capital Markets Model protections, we expect 10-year returns for global equities to land in the 4.5%-6.5% range. This is approximately half of the average equity returns that investors have earned historically, over the long term.
There are two reasons for these subdued return expectations: 1) we anticipate current low risk-free rates to persist (rates are 1 to 2 percentage points lower than in the previous decades) and 2) we're starting today from much higher asset valuations, which further compresses the equity risk premium you would expect to receive on top of the risk-free rate.
Global diversification will be imperative going into 2019, as U.S. expected equity returns will be lower than those of global or international markets over the next decade. Vanguard's outlook for U.S. equities over the next decade is in the 3%-5% range and we can expect to see equity valuations continue to contract from the currently stretched level. For non-U.S. equities, investors will likely see returns in the 6%-8% range.
Longer-term challenges aside for equities, it's important investors focus on factors they can control. Timing the market and trying to seek tilt strategies for additional yield, while tempting, are unlikely to escape the forces of lower portfolio returns.
Additionally, in the near term, bouts of market volatility are likely to occur well into 2019 as global monetary policy continues to normalize and trade tensions between the U.S. and China ebb and flow. These are not dire predictions, however. We view them as necessary for setting reasonable expectations for portfolio returns in the years ahead. Investors should continue to adhere to time-tested investment principles such as maintaining a long-term focus, employing a disciplined asset allocation and conducting periodic portfolio rebalances.
Bold prediction for 2019: At the market level, expect the unexpected. At the company level, the best business models will win.
I am focused on finding long-term, secular growth stories that will prove to have been extremely cheap on a multi-year basis. Sometimes those growth stories have well-established, proven business models and simply need to compound earnings over time, as American Tower, Visa and Alphabet have done over the past decade or so. Other times, I have invested in a business model emerging before the market really believes in it, as was the case for Carvana, The Trade Desk, Wix and Wayfair. My focus is on business models that benefit from long-lasting secular trends and are resilient to unpredictable cyclical impacts.
Some of these secular trends may sound old — but the fact they have powered through a recession or two does not necessarily mean that they can't thrive for years to come. A few examples would be: the movement of advertising dollars from traditional media to the internet; the disruption of traditional retail models by e-commerce and omni-channel models; the disruption of the global tobacco industry by new devices that are cheaper and less harmful than cigarettes; the unquenchable thirst for wireless data across the globe; the ongoing improvement in battery technology that drives a multidecade shift away from internal combustion engines and toward electric vehicles.
It is often easy to identify the secular shift itself. The hard part is identifying which business models stand to benefit from that shift in a sustainable way over a multiyear period.
For example, the secular growth in smartphones was dominated by just one set of shareholders at the handset level. What many may not have expected was that the exponential growth in wireless data consumption benefited tower operators to a far greater extent than the carriers or the network equipment providers. Focusing on the nuances of a company's business model helps me identify the secular winners and, hopefully, avoid the more vulnerable, cyclically sensitive companies to the benefit of my fund's shareholders.
Bold prediction for 2019: We believe growth will continue to outperform value. We believe small caps will stage a comeback.
We believe that 2019 will continue to be a stock picker's market and that small-cap growth stocks are well-positioned for 2019 for several reasons:
• Small caps have historically outperformed large caps in a rising interest-rate environment.
• Small caps are typically more U.S.-oriented and have less exposure to international trade friction. • Growth stocks tend to outperform value stocks when economic growth is modest, interest rates are low, and inflation is under control.
• Overall, our analysis indicates that small-cap growth stocks have higher revenue and EPS growth expectations for 2019 compared to small-cap value and large-cap stocks.
• The valuation of small-cap growth is more reasonable now after the correction from August highs.
Since we are late in the economic cycle, we believe economic growth is going to be moderate. Therefore, we believe growth will be scarce and the best way to generate growth will be through innovation. For the companies that we invest in, innovation is a common theme, which we believe is a key driver for long-term growth, regardless of the macroeconomic environment. We look for innovative small companies that can outgrow the economy by providing proprietary products and services with powerful secular drivers behind them. They have the potential to transform and disrupt an industry, gain significant market share with a wide moat in a large and growing market, and deliver durable revenues and sustainable profitability growth.
We also believe the health-care sector will continue to be fertile ground for active management since it is the most inefficient sector with the largest dispersion of winners and losers, and there are strong demographic tailwinds. Aging populations should propel growth despite an economic slowdown.