StonebridgeFOCUS – Outlook 2019: A Good Night’s Sleep

At Stonebridge, we’re always examining the past to understand the lessons we can take away from it. However, we also appreciate that markets are ruthlessly forward looking. For that reason, we also consider what may lie ahead as we develop strategies to help our clients achieve their greatest financial potential.

Recently, Parametric Portfolio Associates published their 2019 Investment Outlook entitled, “Exit Sandman,” which we thought would be of interest.

In brief:

• When it comes to trade, the relationship between the US and China is an area of particular concern.
• The Fed has raised interest rates by 0.25% nine times since December 2015, most recently just before the Christmas holiday. While rates aren’t expected to rise in such rapid succession in 2019, it seems clear that the era of extremely low rates is behind us.
• Markets have a built-in expectation for how these issues will be resolved.

Our purpose in putting this market outlook together isn’t to reflect a “house view” in our investment strategies. We’re humble enough to understand that annual financial forecasts are fraught with error, so our investment strategies aren’t built with the expectation that we can accurately forecast the near term. Rather, our goal is simply to better understand the range of likely outcomes that investors can expect in the coming year—and to help them prepare for any given market scenario.

Of course, as we go through this exercise, it would be foolish to ignore the elephant in the room. US equity markets are coming off a very weak fourth quarter—one that saw the S&P 500® Index shed 13.52% of its value. No doubt the heightened volatility led to a lot of sleepless nights for many investors, and market observers over the holiday season. So, now seems like a particularly opportune time to discuss what may lie ahead in 2019—in other words, what figures to continue keeping us up at night.

Trade Wars: It’s not just China

When it comes to trade, the relationship between the US and China is an area of particular concern. The world’s two largest economies appear headed for an escalation of trade tensions that will most likely negatively affect growth around the globe. But China isn’t the only issue.

As the International Monetary Fund noted in October, there are multiple challenges to growth around the globe, including rising trade barriers that are disrupting the supply chains that have stimulated global growth over the past decade. Trade barriers not only affect the price consumers pay for goods but also have the potential to limit business expenditures, which has a longer-term economic impact.

As the chart below illustrates, it’s difficult to overstate how important trade has become to global growth. Which leaves investors to wonder how disruptive continued trade conflicts can become.

Fed up: the end of quantitative easing and low interest rates

For nearly the past decade, monetary authorities around the globe have undertaken aggressive measures to stimulate economic growth. The US Federal Reserve, for example, grew the size of its balance sheet in the years after the Global Financial Crisis to encourage investors to purchase stocks, bonds, and other risk assets. However, the tide of quantitative easing is ebbing, and 2019 will see it ebb even further.

The European Central Bank announced it would be ending asset purchases in December 2018. And as the chart below shows, the Fed has begun shrinking its balance sheet by allowing Treasuries and mortgage securities to mature and not replacing them. Since it started doing so at the end of 2017, the Fed’s balance sheet has declined from approximately $4.5 trillion to $4.0 trillion.

It makes sense that if quantitative easing was good for risk assets, then its reversal presents a headwind for them. And that’s not the only stumbling block markets may have to overcome: The Fed has raised interest rates by 0.25% nine times since December 2015, most recently just before the Christmas holiday. While rates aren’t expected to rise in such rapid succession in 2019, it seems clear that the era of extremely low rates is behind us.

Everything else that’s keeping us awake

Trade and monetary policy may be two of the biggest challenges ahead, but there is a host of others. For example, as the stimulus from tax cuts in the US fades, will we realize it was simply a temporary sugar high? Will anti-Europe or Euro-skeptic forces gain ground in European elections in the coming year and accelerate fragmentation? Will the US government become further mired in gridlock as Democrats assume control of the house? Will the US address large structural deficits to build a cushion of protection against a future downturn? Or does a split government make that outcome less likely?

Our point of view

It’s only natural to ask: Is there anything we can actually look forward to in 2019? The answer is a resounding yes—all the challenges described above provide an opportunity for good news. Markets have a built-in expectation for how these issues will be resolved. To the extent, resolution happens in a more favorable manner than expected, investors are likely to be rewarded. For example, if China and the US resolve their trade dispute in a timely fashion, equity markets would likely rally. Therefore, the challenge for investors is determining how the year ahead will unfold relative to the expectations already in place.

That ultimately means learning to accept uncertainty. And the best way to deal with ongoing uncertainty in financial markets is to check your emotions at the door and stick to the well-thought-out goals-based career, life and wealth plan you’ve built—the one that acknowledges that markets will rise and fall and that reacting rashly to either scenario isn’t a likely path to success, or to a good night’s sleep.

“The investor’s chief problem, and even his worst enemy, is likely to be himself.”

To learn more about our distinctive goals-based approach to career, life and wealth management or request a copy of the Market Outlook, please do not hesitate to contact our team directly.

We look forward to continuing to provide useful insights and relevant solutions focused on helping you achieve your greatest financial potential.

Thank you for your continued trust and confidence in Stonebridge.

All the best,

Mitch

About Parametric

Parametric Portfolio Associates LLC (Parametric) uses investment science to build and manage systematic investment strategies and to implement custom portfolio solutions providing clients with targeted investment exposures with control of costs and taxes. Based on principles of intellectual rigor, ingenuity and transparency, Parametric seeks to deliver repeatable client outcomes with consistently high levels of service and maximum efficiency. As of December 31, 2018, Parametric managed $216.6 billion in assets on behalf of institutions, high-net-worth individuals and fund investors. Headquartered in Seattle, Parametric also has offices in Minneapolis, Westport, Connecticut, Boston, and Sydney, Australia. For more information, visit parametricportfolio.com.

When Stonebridge decided to introduce an overlay portfolio management solution to its investment process, we chose to work with Parametric and SEI Private Trust Company. In the firm’s 2010 paper, Tax Efficient Investing in Theory and Practice, Parametric presented many of the concepts that now form the basis of Stonebridge’s tax alpha strategy; the added value by reducing taxes on an investment portfolio.