2019 Outlook: The End of Easy (Wells Fargo)


Mixed Picture for the Global Economy

  • Firms are investing more in their businesses, while household borrowing and spending are growing; tight labor market conditions finally have ended years of wage stagnation, and employers are finding it difficult to hire qualified workers
  • Tax reform and government spending stimulus should pass their peak in 2019, and rising wages eventually should slow job growth; these factors are likely to moderate what households and fiscal policy contribute to growth; US economic growth to slow slightly to 2.7% in 2019
  • Outside of US, we anticipate somewhat slower growth in Europe as the UK prepares for Brexit and Germany’s economy enters the latter stages of its expansion; uncertainties surrounding tariffs are a concern for China, yet we expect supportive fiscal and monetary policy to help underpin the country’s economy
  • We expect stable US CPI to support the economy in 2019; inflation forecast is 2.5% for 2019; in Europe and Japan, inflation should recover enough to prompt central bankers to remove more monetary policy support; for emerging markets, we expect steady inflation at rates below 15-year averages

End of the Dollar as King

  • Expect USD strength to wane in 2019, allowing moderate appreciation of the euro and yen as well as recovery for many EM currencies
  • Fed rate increases may end by late 2019, while developed market central banks, such as the ECB and the BoJ begin to remove their extraordinary stimulus measures of recent years

US EPS and Equity Prices Both Have Room to Rise

  • Household and business spending should keep profit margins at sustainable levels; EPS for large-cap benchmark index should have additional support from repatriated overseas profits; some of this cash is likely to be used in share buybacks to reduce outstanding share counts, which increases EPS
  • Expect a US-China trade deal to support valuations but higher interest rates and slower EPS growth should restrain the upturn in sentiment
  • Overall, we expect low double-digit price returns for large-cap equities and high single-digit returns for mid-caps
  • Valuation is the main reason we find the Health Care, Financials, and IT sectors attractive; we also favor the Consumer Discretionary and Industrials sectors, which should benefit from the solid pace of consumer spending, an improved rate of business spending, and steady economic growth overseas

We see three Fed rate hikes in 2019

  • Expect the Fed to hike rates 3 times in 2019, bringing the fed funds rate to a range of 3% to 3.25%
  • Also see the Fed slowing or ending its balance sheet reduction in 2019 or early 2020
  • As the Fed increases short-term rates, we look for longer-term rates to drift higher; expect the 10-year Treasury yield to end the year between 3.25% and 3.75%

Risk Grows for High-Yield Debt

  • It is difficult to find any valuation metric that would classify high-yield debt as inexpensive; quite the contrary, most valuation measures show that high-yield debt is quite expensive
  • We remind investors that significant and unexpected credit events can occur with little warning
  • Recommend investors consider moving up in credit quality given the asymmetric risk/return profile currently inherent in lower-rated credits
  • Muni credits should experience continued relative strength throughout 2019, as constrained supply and increased investor demand in higher-tax states should lead to tighter yield ratios versus taxable counterparts

Commodities are Likely to Rebound

  • Commodities underperformed other real assets for most of 2018; we viewed this level of underperformance as unwarranted given outlook on the dollar, trade disputes, and global economic growth
  • For the first time in years, we are entering a new year bullish on crude oil; believe that $50-60/bbl reflects the underlying supply-demand fundamentals for US WTI; we add a $10/bbl expected premium for geopolitical concerns and for potential oil production cuts by OPEC; 2019 WTI target range is thus $60-70/bbl
  • YE target range for gold is $1,250-$1,350 per troy ounce which means that we’re expecting modest upside

MLPs Have the Potential to Outperform Other Real Assets

  • Showed some good relative price action in the back half of 2018; with oil prices poised to bounce in 2019, we suspect that investors will favor MLPs
  • Fundamentals are improving and prices look cheap relative to comparable assets
  • We favor MLPs that are large, broadly diversified, and well capitalized

Corporate Credit Sector Offers Opportunities

  • At the end of September 2018, more than 49% of the Bloomberg Barclays US Aggregate Bond Index was rated Baa/BBB
  • Notably large proportion of these bonds implies a potential for large-scale downgrades if fundamentals deteriorate
  • Capitalizing on these potential fallen angels is but one of several reasons we are increasingly optimistic about long/short credit and event driven strategies

Neutral on Private Equity and Unfavorable on Private Real Estate

  • PE purchase multiples are at or above historical levels, and large manager cash holdings could raise multiples in 2019
  • For private real estate, a lesson of the long US expansion is that real estate supply and demand conditions eventually deteriorate, often as interest rates rise, and negatively affect US property cap rates and property values

5 Ways Investors Can Position Portfolios for the End of Easy

  • Position for growth in equity markets
  • Maintain positions in high-quality fixed income
  • Diversify into international assets
  • Lower allocations to the most rate-sensitive assets
  • Deploy cash as volatility creates opportunities

Wells Fargo 2019 Outlook: The End of Easy, December 2018

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