BofA Merrill Lynch 2019 Market Outlook: From Peak to Trough, the Market Unfriends Stocks and Bonds, Likes Volatility, and Swipes Right on Cash
Showing its age, the long bull market cycle of excess stock and bond
returns is expected to finally wind down next year, but not before one
last hurrah, according to BofA Merrill Lynch Global Research, which
today issued its outlook for the global markets and economy in 2019. The
bear market vibe at the end of 2018 is expected to continue, with asset
prices finding their lows in the first half of the 2019 once rate
expectations peak and global earnings expectations trough; however, BofA
Merrill Lynch also forecasts a record high peak in earnings for the S&P
500 next year and plenty of upside potential for investors who make
volatility their new best friend.
“In our view, the current weakness in the markets is not a reflection of
poor fundamentals. Rather, it’s caused by a confluence of idiosyncratic
shocks that create very real risks for investors to be concerned about
but also opportunities for vigilant, well-positioned investors to
pursue,” said Candace Browning, head of BofA Merrill Lynch Global
Research.
For the year ahead, the Research team forecasts modest gains in equities
and credit, a weaker dollar, widening credit spreads, and a flattening
to inverted yield curve, signaling a tighter squeeze on liquidity that
calls for higher levels of volatility. This comes against a backdrop of
slowing, but still-healthy economic growth; mild inflation, except in
the U.S. where inflationary pressures are building; and a notable
slowing in global EPS growth from the torrid pace of 2017 and 2018.
Two big themes are expected to affect asset returns and the pace of
economic growth in 2019: (1) An unprecedented level of global monetary
policy divergence as the U.S. Federal Reserve continues to hike interest
rates and other major central banks don’t; and (2) whether a strong U.S.
economy decoupled from the rest of the world, particularly Europe and
China, can be sustained. The answer to that question could depend on big
wild card risks in 2019: resolution of the trade war between China and
the U.S., an EU political/economic crisis, and political gridlock in the
U.S. that could slow capital investments and deteriorate investor
sentiment.
Analysts from the top-ranked global research firm summarized their views
on the market and made the following 10 macro calls for the year ahead:
1. Global profit growth declines: Earnings growth is expected to
decline sharply next year, from >15 percent to <5 percent on a
year-over-year basis. The BofA Merrill Lynch Research team is bearish
stocks, bonds, and the U.S. dollar; bullish cash and commodities; and
long on volatility. We expect to turn tactically risk-on in late spring,
but to start 2019 with a bearish asset allocation of 50 percent stocks,
25 percent bonds and 25 percent cash.
2. S&P 500 Index peaks: Earnings growth also is likely to
slow in the U.S., though the near-term outlook remains somewhat
positive. The Standard and Poor’s 500 Index is expected to peak at or
slightly above 3,000 before settling in at a year-end target of 2,900.
We forecast earnings per share (EPS) growth of 5 percent, which would
put the S&P 500 EPS at a record high of $170 next year. Our U.S. equity
strategists are overweight health care, technology, utilities,
financials and industrials, and underweight consumer discretionary,
communication services and real estate.
3. Cash gets competitive: For most of this long cycle, cash
yields couldn’t hold a candle to more compelling asset class
alternatives like stocks and bonds; with cash yields higher than
dividend yields for 60 percent of the S&P 500 already, cash becomes even
more competitive in 2019. Our Fed call puts short rates close to 3.5
percent by the end of 2019, well above the S&P 500’s 1.9 percent
dividend yield. Moreover, in a rising-rate environment, cash-generative
investments have outperformed credit-sensitive assets. Given cash’s
re-rating, 2019 boils down to a strategy of buying sources of cash and
selling users of cash.
4. U.S. economy slows as fiscal stimulus fades: Real U.S. GDP
growth of 2.7 percent is forecast for 2019, slowing in the second half
of the year as the effects of fiscal stimulus begin to fade. The
unemployment rate could reach a 65-year low of 3.2 percent by year-end,
pushing wage growth of 3.5 percent in aggregate. Consequently, core
price inflation should gradually rise to 2.2 percent through 2019 and
hold as rates continue to rise. The housing market is no longer a
tailwind for the U.S. economy: we believe housing sales have peaked and
home price appreciation is forecast to slow.
5. Global economic growth decelerates: The global economy is
forecast to grow 3.6 percent in 2019, down slightly from 3.8 percent in
2018, with inflation hovering around 3 percent. Most major economies are
likely to see decelerating activity, with real GDP growth of 1.4 percent
in both Europe and Japan, and 4.6 percent growth in aggregate among the
emerging markets. Chinese growth is likely to further weaken early next
year as a result of still-tight financial conditions and the U.S.-China
trade conflict; however, a steady stream of monetary and fiscal stimulus
measures to turn the economy around is expected.
6. Global monetary policy divergence: Global monetary policy is
expected to become less friendly in 2019. A divided government means
that additional fiscal stimulus in the U.S. seems unlikely. Europe is
largely frozen in place by its budget rules, and Japan appears ready to
implement yet another ill-timed consumption tax hike, in our view.
Further divergence in monetary policy between the Fed and other major
central banks is expected to continue. We forecast the Fed will hike
rates four times in 2019, reaching a terminal funds rate of 3.25-3.50
percent by year-end. Meanwhile, the European Central Bank and Bank of
Japan are unlikely to raise policy rates meaningfully above zero for at
least another two years.
7. Credit cycle continues despite widening spreads and flattening
curves: Globally, the credit markets face high levels of episodic
volatility in 2019 with shrinking supply and quantitative tightening
putting 25 to 50 basis points of upward pressure on investment grade and
high-yield bond spreads. In the U.S., total returns of 1.42 percent are
forecast for high-grade corporate bonds and 2.4 percent for high yield.
The U.S.-leveraged loan market remains a bright spot in the credit
spectrum, with total returns of between 4 and 5 percent. High-grade and
high-yield corporate credit are expected to deliver total returns of 1
percent in Europe and, in Asia, 3 percent and 4.9 percent, respectively.
8. Emerging markets: After a major sell-off in 2018, emerging
market assets are cheap and under-owned and could be a big winner in
2019 as the dollar weakens, yet EM remains highly vulnerable to
spillover effects of U.S.-China trade tensions. We are bullish Brazil
and expect its post-election rally to continue, and Russia is expected
to improve as we believe sanction risk is priced in. Meanwhile, the
outlook is bearish for Mexico, where credit rating downgrades are a
concern and volatility surrounds policy changes under its new president.
9. Foreign exchange volatility on a weaker dollar: The U.S.
dollar was the best performing asset class in 2018, however, most of the
dollar gains appear to be in the past. A weaker dollar is expected in
2019, against a stronger euro and Japanese yen. We forecast the EUR/USD
and USD/JPY to reach 1.25 and 105, respectively at year-end. The
strength of the dollar will depend heavily on evolution of the trade
relationship between China and the U.S., which in the short term may
mean selling the dollar against a currency insulated from trade war
rhetoric, such as the British pound and Swiss franc.
10. Commodities modestly positive: The outlook for commodities is
modestly positive despite a challenging global macro environment. We
forecast Brent and WTI crude oil prices to average $70 and $59 per
barrel, respectively in 2019; weather-induced volatility is expected in
the near term for U.S. natural gas, as cold weather could propel winter
natural gas over $5/MMbtu, yet we remain bearish longer term on strong
supply growth. In metals, we remain cautious about copper because of
Chinese downside risk. We forecast gold prices will rise to an average
of $1,296 per ounce, but could rally to as high as $1,400, driven by
U.S. twin deficits and Chinese stimulus.
Detailed highlights of BofA Merrill Lynch Global Research reports can be
found here.
BofA Merrill Lynch Global Research
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