Revisiting 4 Key Risks for 2019
- April 24, 2019
We remain optimistic on fundamentals and global growth, but risks have increased.
At the end of 2018, we identified four key market risks to look out for in 2019: rates, trade, Brexit/populism, and oil. As we progress into the second quarter of the year, all four of the risks outlined continue to be concerns and meaningful market drivers. Despite these risks stirring up volatility at the end of the first quarter, the markets have delivered fairly attractive returns, especially in the United States. Let’s review these four key market risks through the end of the first quarter and discuss their potential impact.
Risks
Since the end of the fourth quarter, there has been a Fed “pivot” on rates. What was once a path to two rate hikes in 2019 has become an expectation of no rate hikes this year. The futures market is even pricing in a small probability of a rate reduction if declining growth expectations don’t stabilize. In the fourth quarter, we recognized that a slowdown in domestic and global growth may be enough to keep monetary policy accommodative for much of 2019. So far, this is proving to be the case. As long as domestic and global growth remains at or close to trend, we see the Fed’s pivot as a win for risk assets.
The new dynamic that emerged late in the first quarter was the dreaded inversion of the Treasury yield curve, which spooked the markets. An inversion, when short-term rates are higher than long-term rates, is perceived as a precursor to a recession. While nothing can be a perfect predictor of the future, the inversion of the yield curve has occurred prior to the last seven recessions. In our view, this is less of a concern in the immediate future as 1) the inversion so far only occurred for a short time, 2) the inversion does not indicate the timing of a recession and 3) the two-to-10 year spread still remains positive and is viewed by many market observers as a more meaningful representation of the yield curve.
Over the past seven periods of inversion, the economy hit a recession anywhere between seven and 19 months. While domestic and global growth is not as robust as it was a year ago, we feel the later portion of this economic cycle still has legs and it is highly unlikely we will see a recession in the near future. This view is predicated on three main factors: a strong labor market, a dovish Fed and attractive earnings growth.
Trade is a factor that is weighing heavily on global growth. We reached the end of the first quarter without a trade deal. While trade negotiations continue between the United States and China, the impact extends to Europe and other emerging-market countries. Trade tensions have disrupted GDP growth and the continuation (or escalation) of trade tensions is a negative outcome for both parties. It’s in the interest of all parties and the global economy that a resolution be reached. Therefore, we believe it is not a matter of if a resolution will be reached, but when.
Populist sentiment continues to transcend politics globally, from the
“yellow vests” in France to the Five-Star Movement in Italy. Chief among the headlines of late has been the U.K.’s Brexit referendum, which has significant economic repercussions not only for the U.K. but also for Europe. Europe has been experiencing weakening economic data and a hard Brexit (no deal) could have serious economic implications. As a result, we continue to believe an amicable Brexit agreement will be reached. In this scenario, we believe Europe’s equity markets would get the biggest boost, as near-term uncertainty rolls off.
However, with parliamentary opposition pressing U.K. Prime Minister Theresa May, outcomes range wildly from the prospect of another general election to no Brexit at all. While bouts of volatility may occur, we expect investors to continue pacing themselves in this marathon, digesting new information as it comes, much like they have done over the past three years.
The slowdown in global growth has led to a worldwide decline in oil demand. However, oil markets are still heavily influenced by members of the Organization of the Petroleum Exporting Countries (OPEC), which has worked together to limit supply in addition to U.S. sanctions on Iran’s and Venezuela’s exports. As a result, oil prices rose to $62.47 at the end of March from $45.51 at the start of 2019. Our 2019 view that the supply-and-demand mismatch will be rectified, resulting in higher oil prices, has occurred sooner than anticipated. Still, we believe that oil markets and commodity markets in general will remain volatile given the uncertain global growth picture and the duration of OPEC’s collective supply cuts. Therefore, we continue to tread cautiously in the coming year by keeping an eye on production and leaning heavily on valuations and fundamentals to drive commodity-sensitive investments.
Our views
Our overall asset class views haven’t changed since we published our 2019 outlook. We firmly believe that inflation is at bay, fundamentals remain intact and economic growth continues, albeit at a slower rate. We feel that recession risk is not a current concern but it is something to monitor as some recession indicators are beginning to flash red. We remain committed to current positioning and continue to emphasize portfolio diversification. At the same time, now could be an ideal opportunity to allocate excess cash to segments of the market we find most attractive. The Asset Class Detail section on the next page summarizes our views within and across asset classes.
Disclosures
The opinions expressed herein are subject to change without notice. The information and statistical data contained herein has been obtained from sources we believe to be reliable. Past performance is not a guarantee of future results. The above discussion is for illustrative purposes only and mention of any security should not be construed as a recommendation to buy or sell and may not represent all investment managers or mutual funds bought, sold, or recommended for client’s accounts. There is no guarantee that the above-mentioned investments will be held for a client’s account, nor should it be assumed that they were or will be profitable. The Consulting Group is a division of Oppenheimer Asset Management Inc. (OAM). OAM is an indirect, wholly owned subsidiary of Oppenheimer Holdings Inc., which also indirectly wholly owns Oppenheimer & Co. Inc. (Oppenheimer), a registered broker dealer and investment adviser. Securities are offered through Oppenheimer. For information about the advisory programs available through OAM and Oppenheimer, please contact your Oppenheimer financial advisor for a copy of each firm’s ADV Part 2A. Adopting a fee-based account program may not be suitable for all investors; anticipated annual commission costs should be compared to anticipated annual fees.
S&P 500 Index measures performance of U.S. large-cap companies.
MSCI AC World ex-USA Index captures large- and mid- cap representation across 22 of 23 developed-market countries (excluding the US) and 24 emerging-market countries.
LTM PE Ratio is the last 12-month price-to-earnings ratio.
Indices are unmanaged, do not reflect the costs associated with buying and selling securities and are not available for direct investment.
Risk Factors - The success of an investment program may be affected by general economic and market conditions, such as interest rates, the availability of credit, inflation rates, economic uncertainty, changes in laws and national and international political circumstances. These factors may affect the level and volatility of securities prices and the liquidity of a portfolio’s investments. Unexpected volatility or illiquidity could result in losses. Investing in securities is speculative and entails risk. There can be no assurance that the investment objectives will be achieved or that an investment strategy will be successful.
Special Risks of Foreign Securities - Investments in foreign securities are affected by risk factors generally not thought to be present in the United States. The factors include, but are not limited to, the following: less public information about issuers of foreign securities and less governmental regulation and supervision over the issuance and trading of securities. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Special Risks of Small- and Mid-Capitalization Companies - Investments in companies with smaller market capitalization are generally riskier than investments in larger, well established companies. Smaller companies often are more recently formed than larger companies and may have limited product lines, distribution channels and financial and managerial resources. These companies may not be well known to the investing public, may not have significant institutional ownership and may have cyclical, static or moderate growth prospects. There is often less publicly available information about these companies than there is for larger, more established issuers, making it more difficult for the Investment Manager to analyze that value of the company. The equity securities of small- and mid-capitalization companies are often traded over-the-counter or on regional exchanges and may not be traded in the volume typical for securities that are traded on a national securities exchange. Consequently, the investment manager may be required to sell these securities over a longer period of time (and potentially at less favorable prices) than would be the case for securities of larger companies. In addition, the prices of the securities of small- and mid- capitalization companies may be more volatile than those of larger companies.
Special Risks of Fixed Income Securities - For fixed income securities, there is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time.
Liquidity Risk. Liquidity risk is the risk that you might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. When a bond is said to be liquid, there's generally an active market of investors buying and selling that type of bond.
Market risk: Fixed income securities markets are subject to many factors, including economic conditions, government regulations, market sentiment, and local and international political events. Further, the market value of fixed-income securities will fluctuate depending on changes in interest rates, currency values and the creditworthiness of the issuer.
Special Risks of Master Limited Partnerships: Master limited partnerships are publicly listed securities that trade much like a stock, but they are taxed as partnerships. MLPs are typically concentrated investments in assets such as oil, timber, gold and real estate. The risks of MLPs include concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy and market risk. MLPs are not suitable for all investors. 2511313.1