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 ResearchThe BofA Merrill Lynch Global
Research franchise covers more than 3,000 stocks and 1,000 credits
globally and ranks in the top tier in many external surveys. Most
recently, the group was named No. 2 Global Research Firm of 2018 by
Institutional Investor magazine; No. 1 in the Institutional
Investor 2018 Emerging EMEA survey; No. 2 in the 2018 All-Europe
Fixed Income, All-America Fixed Income, All-America and All-China
surveys; No. 3 in the 2018 Institutional Investor All-Europe
survey; and No. 4 in the 2018 Institutional Investor All-Asia
survey. For more information about any awards cited, visit
https://go.bofa.com/awards.
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