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4 Key Market Risks for 2019

  • Oppenheimer Asset Management
  • January 10, 2019
We remain optimistic for the new year, but uncertainties carry over from a challenging 2018.
Oil pipeline

After a hot start, albeit brief, 2018 proved to be a rather unsettling year. Despite global economic growth projected to reach 3.1% and earnings growth forecasted to exceed 15% for the MSCI World Index this year, market returns were rather disappointing1. The S&P 500 returned -5.9% year-to-date through Dec. 20, on the heels of 117 days of negative performance and its worst daily drawdown of -4.1%. We believe Fed rate hikes, global trade tensions, ongoing populism and oil-price volatility combined to curb investor enthusiasm. Looking ahead to 2019, we are evaluating each of these catalysts in hopes of discerning between temporary noise and fundamental concern.

Risks

The consensus for 2019 Fed rate hikes is quite balanced at this point. Currently, the most likely option seems to be two rate hikes in 20192, especially after Chairman Jerome Powell's recent statements that rates were "just below" their neutral level. Further, with their ongoing claim to be data-dependent, we believe waning labor growth and the manageable pace of inflation may keep the Fed from making significant changes to their telegraphed policies. However, with geopolitical uncertainty on the rise, domestic and global growth remains vulnerable and may be enough of a concern to keep monetary policy accommodative through 2019—a win for risk assets. However, in the unlikely event that economic growth and inflation accelerate, the Fed may be forced to rethink its strategy and tighten more aggressively. In that scenario, we expect further downward pressure on global stocks. In a worst-case scenario, the possibility of U.S. stagflation—the divergence of slowing growth and rising inflation—presents a deep and more complex challenge for the economy and financial markets.

The latest shift in global growth expectations comes on the heels of a deep selloff in financial markets. While much of 2018 has been defined by trade tension, we believe there is a strong chance for resolution in 2019 as a formal trade war with China is a winless outcome for both parties. If a resolution were to be reached, then a heavy burden would be lifted from equity markets and multiples would likely expand once again. For one of the hardest-hit sectors, emerging markets would most likely be the biggest beneficiary of a formal resolution.

For now, the politically charged nature of this situation, and the uncertainty of a solution to trade talks with China, is keeping optimism at bay. The consequences of escalating trade actions are undeniable: higher prices in China and the United States, less purchasing power for consumers, higher input costs, heightened financial market volatility and possibly higher interest rates. All of these risks come with an even greater concern: contagion. We don’t use that term lightly. The global economy is more connected than ever, making this a significant risk to all markets. A resolution to the U.S./China trade talks would reduce uncertainty that has burdened global equity markets.

The support for populist parties globally has reached its highest level since the early 1930s, according to Bridgewater Associates. While not a new phenomenon, the surge in populism beginning in 2016 was notably influenced by the Brexit referendum, the election of Donald Trump and the rise of Italy’s Five Star Movement. Unlike typical political risks, however, this one has the potential to create significant challenges for economic and market growth. Protectionism has the ability to curb productivity growth, spark inflation and squeeze corporate margins—a bad recipe for economies and markets alike. The key questions for 2019 are whetheror not the populist movement accelerates and how will the market continue to digest this trend.

We focus our attention on Europe in 2019, as populist sentiment could be swept under the rug if an amicable Brexit agreement is reached and tensions between Italy and the European Union ease. In this scenario, we believe European equity markets would get the biggest boost, as uncertainty in the near term rolls off. However, with parliamentary opposition pressing 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.

In strong support of the so-called “energy renaissance” domestically, the United States officially became a net oil exporter for the first time in 75 years (at least for the week ending Nov. 30). Unfortunately, this milestone was met during another substantial selloff in crude prices in the fourth quarter. In theory, the accomplishment means the United States is on its way to energy independence; however, in reality, the oil market is still wildly influenced by OPEC, Russia and other countries. Further, what appears to be compounding the decline in oil prices are renewed fears over a decline in oil demand driven by technological innovations as well as the reluctance of some nations to reduce output due to their economic dependence on oil revenue. The International Energy Agency (IEA) trimmed forecasts for world oil demand growth this year and next year while citing “global oil supplies are growing rapidly, as record output from Saudi Arabia, Russia and the United States more than offsets declines from Iran and Venezuela.”3

We believe the energy renaissance is in its early infancy. Heading into 2019, for the supply-and-demand mismatch to be rectified, there needs to be a concerted effort by OPEC and other nations to curtail supply and the settling of global trade concerns (demand). However, commodity markets will remain volatile as the world adjusts to the new landscape of production. Therefore, we will tread cautiously in the coming year, by keeping an eye on production and leaning heavily on valuations and fundamentals to drive commodity-sensitive investments.

While globalization has benefited from the structural advancement of the world economy, it has also created a deep and complex web of relationships. As markets rarely operate in a vacuum, we expect these risks to remain highly linked to one-another. While we may not be certain how any of these risks will ultimately play out, we believe our fundamental views should prove correct over the long-term.

Our Views

Our asset class views in general have not changed despite the recent turmoil in global markets. We firmly believe that inflation is at bay, fundamentals remain intact and economic growth continues—albeit at a slightly slower rate. 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. Learn more by consulting with an Oppenheimer Financial Advisor.

Disclosures

1 Source: World Bank, Factset
2 Source: CME Group
3 https://www.iea.org/oilmarketreport/omrpublic/

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. 2353735.3

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