athenacapital

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WHAT WILL SHAPE THE MARKETS IN 2019 A GAME OF 20
QUESTIONS, PART II
To the extent one can ask the right questions,
the best available answer is often something
other than a concrete yes or no. Rather, one
has to use ones best judgment based on an
assessment of the probabilities. It is in that
vein that my posts this month are modeled after
20 Questions, with my best sense of the relevant
probabilities provided for the 20 issues I
believe are likely to prove the most germane over
the course of 2019.
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This post is part two in a four-part series.
Questions one through five can be read here and
the final ten questions can be read in
parts three and four. 6) Will the US dollar
weaken after its strong run in 2018? 55
probability. Few if any macro forecasts are
easy, but over time weve found currency
forecasts to be the most challenging. In theory,
currency strength should be driven primarily by
the countrys relative economic growth rate and
bond yields. In reality, there are a myriad of
factors at work, including a significant role
played by traders/speculators, many of whom
gravitate to the greenback as a preferred safe
haven in times of rising uncertainty. Indeed, to
the extent we expect the trade-weighted dollar to
decline modestly this year (say 3-5,
essentially reversing gains seen in 2018), it is
largely because futures-based positioning in
favor of dollar strength is currently at a
three-year high. Merrill Lynch recently termed it
the most crowded trade in the market. If we are
correct that the Fed remains largely on hold,
President Trump could get his seemed wish for a
weaker dollar that would aide US exporters,
providing at least a modest tailwind for SP 500
earnings. Importantly, a weaker US dollar would
tend to ease the pressure recently placed on
emerging markets, particularly China. Equity
markets began to recover in 2016 after the
so-called (but never publicly confirmed) G20
Shanghai Accord that combined Chinese stimulus,
a less hawkish Fed and OPEC production cuts to
spearhead synchronized global growth. The ongoing
US/China trade talks could serve as the basis of
a Shanghai II type of accord.
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7) Will the 2/10 year US Treasury curve
invert? 30 probability. This prediction could
be proven wrong very quickly given that the curve
is currently less than 20 basis points from
inversion. Still, our view is that a near-term
peak in the Fed funds rate, combined with
resilient (albeit modest) economic growth will
allow the curve to gradually steepen over the
balance of the year. An important point to keep
in mind is that the traditional signaling effect
of an inverted curve may be less meaningful than
in the past due to the massive bond buying by
central banks related to quantitative easing, the
hallmark of this unique economic and market
cycle. 8) Will SP 500 earnings exceed the
current 8 consensus forecast in 2019? 35
probability. While 2018 was essentially defined
by stellar 20 earnings growth (fueled in large
part by the one-time impact of the late 2017
corporate tax cut), more than offset by multiple
contraction, we expect the opposite trends to
prevail in 2019. The markets 4Q18 sell-off
coincided with sharply negative earnings
revisions for 2019 due primarily to expected
margin compression. The Street has become
increasingly concerned that weakening revenue
growth due to a slowing global economy and rising
input costs (wages in particular) could even
result in an earnings recession akin to what
occurred in late 2014 into early 2016. We do not
anticipate a second earnings recessionif nothing
else, the prior one was exacerbated by plunging
oil prices and crude prices are starting from a
much lower base this time around.
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Moreover, as noted, we expect a somewhat weaker
US dollar to provide some support for US
multinationals. However, we do expect aggregate
earnings growth to be mired in the low to
mid-single digits for the year, implying that
multiple expansion will be needed for US equities
to deliver an above average annual
return. 9) Will global and US earnings multiples
continue to contract in 2019? 25
probability. The global one year forward P/E
ratio hit a six year low of just under 13x in
December, well below the 16x level reached early
last year. The sub-13 figure was last seen during
the latter portion of the European sovereign debt
crisis in 2012. The market clearly does not
believe the recent FactSet consensus global
earnings growth forecast of about 12 in 2019,
which is well above the 6 actual average for the
last five years. Of course, further contraction
is possible (global P/Es bottomed at about 10x
in 2009 and 2011). However, given our view that
neither a global nor US recession is likely this
year, we expect multiples to stabilize and
probably rise over the course of the year. Asian
multiples (particularly China) saw the largest
reduction in 2018 and probably have the most
upside. As for the US where one year forward P/E
multiples contracted from about 18x last January
to 14x at year-end, we expect modest expansion
back toward 15xthe average multiple for the last
decade. A key underlying assumption for that
normalization is our view that 10-year Treasury
rates do not move much past 3 over the course of
the year.
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10) Will populism cause significant strife in
Europe in 2019? 25 probability. Rising populism
is, of course, only one potential risk to the
European economy and markets in 2019. After all,
it is not as if the continent has been knocking
the proverbial cover off the ball for the better
part of the 20-year-old Euro-era. While populism
in countries such as Italy and more recently
France may soon trigger a temporary boost to GDP
growth via fiscal stimulus, history says that the
boost will be short-lived. The structural
barriers to EU growthfrom the challenge of
navigating monetary union without fiscal union to
the tensions between the more prosperous north
(Germany in particular) and the less prosperous
southremain formidable impediments to the
Unions long-term vitality, if not viability, in
our view. While Italy likely warrants particular
scrutiny, we see little reason for Europe to veer
significantly from its muddle through 1-1.5
or so real GDP growth trajectory in 2019.
Importantly, lackluster growth does not imply
that European equities are surefire laggards.
Most successful European companies are heavily
export-oriented. Many trade at seemingly
undemanding valuations relative to other
developed markets, even when adjusting for the
relative dearth of higher growth, higher multiple
(read technology) companies. Article
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