Outlook 2019: Economies grow; financial markets struggle

Three themes underlie the evolution of the world economy and financial markets in 2019. First, the economic and monetary policy environment is radically different from any time since 2008. The period from 2008 to mid-2016 was an economic morass: US growth was weak, the world endured a series of financial crises, and there was a generalized fear that this ugly phase would worsen or stick around forever. Petrified of deflation, central banks pushed interest rates to record lows and inundated investors with trillions of dollars of liquidity, pushing most asset prices higher. Stock markets became an extension of monetary policy.

As the world left that morass in mid-2016 and gathered steam throughout 2017, fears of secular stagnation receded. This vastly improved global economy needs more normal interest rates and less accommodative policy. So, an investment universe that had become accustomed to super-low yields, and pushing the risk envelope to find yield, had to adjust. As it did, financial markets struggled, turning flat to down for the year through November. As more central banks tighten policy, market turmoil could get worse.

Second, there is a broad divergence between a robust real economy and turbulent financial markets. That’s especially true in the United States, where Main Street has clearly been outperforming Wall Street. The US labor market is red-hot, business and consumer confidence are near records, and wage gains are accelerating. But, financial markets are besieged precisely because the economy is strong and confidence high. The fight against deflation and anemic growth has been won; so, the surge of liquidity provided during the financial crises is being withdrawn. This divergence could continue as rising long-term interest rates precipitate a moderate bear market in US stocks in 2019, even as the real economy remains resilient. As US stocks underperform the rest of the world, the US dollar may slide.

Last, investors seeking returns may need a stopwatch in 2019, because timing makes the difference between profit and loss. The nine-year US stock market surge promoted passive portfolio management, since investors could just jump on the trend and be rewarded. That likely won’t work next year; investors may get whipsawed by rapidly changing trends. Financial profits may come only to those with good timing. For most investors, it’s probably a year to take less financial risk and protect one’s portfolio. The economy may be able to weather the financial storm if it comes. Prudent investors who limit downside risk with a conservative portfolio should be okay.

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