Surveying the Investment Landscape in 2019
Lord Abbett's Investment Perspectives
Surveying the Investment Landscape in 2019
A Roundtable Discussion
Joseph Graham: Tom, do you have any expectations or areas that you expect to be good areas in 2019?
Thomas O'Hallloran: I think growth will do well in 2019. I don't expect economic growth to accelerate from here. It seems to be decelerating a little bit, notwithstanding the government - spending that we have ahead. The tech revolution is enabling a lot of great innovation in [the] consumer [and] healthcare [sectors], and in tech itself. So I see a lot of companies that are going to grow at double-digit rates - many of them at high double-digit rates, if not triple-digit rates.
So, there's tremendous innovation going on in the economy. And I'm very optimistic - intermediate and long term - on equities and on growth. As I said earlier, I think the challenge is going to be not just what the Fed does, but what the Fed will be made to do by the data that comes out now that it's data dependent.
But we are clearly in a corrective phase. Something changed in October. We had a breakout to new highs in September. That failed miserably. FAANG lost its leadership. Many other growth areas lost their leadership. If you look at the top performing industry groups - recently, they are utilities [and] consumer staples - they are not very exciting sectors. They are defensive [groups]. And so we need to see that change. And when that [will] happen, we don't know. But I do share Kew and Giulio's view that this economic recovery could have a long way to go. Inflation is under control. That's really critical that it stays that way. There's a risk of it flaring up. But right now it's stable. And as long as those two things happen, continued growth [and] contained inflation, equities should do fine in the year ahead.
Graham: Giulio, any risks or opportunities that the market isn't fully appreciating next year?
Giulio Martini: I think after this selloff [in October-November 2018] that the markets are actually priced pretty attractively. If [you] look at earnings growth in the United States, we have 25% earnings growth year-over-year in 2018. And the multiple on forward earnings expectations peaked at about 18.2 back in September. It's now down under 16; the long-term average for that forward multiple is 16.2. So we're actually in a situation where if we just get the mid-to-single digit earnings growth that's priced in for next year, the market actually could do pretty well in terms of giving you [earnings growth in] the high single digits.
At the same time, we had high yield spreads, you know, contract to as low as, you know, 315 [basis points] or so on option adjusted spreads. We're now at 420 or something like that. And in a benign economic environment, you could not only pick up the yield advantage in high yield, which is roughly 6% yield compared to [U.S.] Treasuries around 3%, but you could see some spread compression as well.
And the same thing for investment grade, which has widened out quite a bit. So, in an environment where inflation stays close to 2%, where the economy just grows somewhere around 2 - 2.5%, which looks quite reasonable, I think U.S. assets are actually priced attractively. And I think in many ways, the wild card for overseas markets is the dollar, particularly for emerging [markets]. Because if we just get what's priced in right now, and the Fed gives us another couple of tightening moves, and then pauses to assess the situation, then I think we could have an environment very similar to what we had in the mid-2000s, where the United States is tightening policy, but it's discounted in markets.
[In that case] the dollar doesn't rise much more than it already has. And that, I think, would clear the way for a better environment for emerging market asset spreads as well as equities. So I see a good environment. The [other] wild card in my mind is trade. Because the way that U.S. economic growth and good economic performance gets translated to the rest of the world is through export and import flows, and through capital markets.
Graham: Kew, what are some of the opportunities or some of the risks [that] you're seeing?
Kewjin Yuoh: I would just say that the expansion does have to end at some point. The rate hikes will eventually lead to tighter financial conditions. And the high rates [will bring] the end of the cycle. But we don't perceive that to be near right now, as many of us have summarized. We did de-risk in September and early October, when we took that signal of higher uncertainty from the Fed. But we're re- risking now, because we agree with Giulio in the sense that the weakness that we've had thus far seems to jibe with a higher level of uncertainty, given the backdrop of the economic fundamentals that we have.
So we feel good about taking opportunities within risk sectors going into 2019. I would say that the one scenario that we're thinking about, which is a bit, perhaps, counter-consensus would be that inflation remains the key issue. To the extent that we have inflation risk premiums come back, and there's significant acceleration there, then I think what you could have is a period of a perverse yield curve reaction, [with] inflation risk premiums coming back and term premiums coming back because of uncertainty and the Fed's data dependency. And what you have is a steeper yield curve while the Fed is raising rates. That does not usually happen. We would take that as an indicator that the bad times are about to come - that the downturn is coming [and] risk assets will not perform well in that environment.
And so we'll be keeping an eye on that. But again, central to what Giulio had been saying, inflation will be key.
Graham: Leah, any other surprises [or] opportunities that you would expect in 2019?
Leah Traub: So I do think that the Fed will be looking at the economic fundamentals, which, as we've talked about, will remain pretty strong, even though we are decelerating from the peak.
We will remain above the trend that we've been in. And what you need to see is obviously a pickup in growth outside the United States.
Until we really start seeing international growth really start picking up, which may not happen right away. I think [it will] be a little bit more towards the end of next year. So what I think you really have to be focused on in order to get back into the emerging markets are the valuations - as I mentioned, they're somewhat attractive, to start adding a little bit [to] positions.
But until you really get comfortable that the dollar can weaken, I think it's going to be a little bit of a struggle for them.
Graham: Dan, how about positioning in the muni side, or expectations for next year? How do you approach it?
Daniel Solender: Well, we're definitely a more domestic-oriented market. So I'll leave the international discussion to everyone else. [As for] some of the things we're looking at in our market to have a big impact this year, one, first of all, is [that this is] the first year we're finishing now where the cap on state and local taxes is $10,000 in a lot of high tax states.
And I think in theory, it's one thing to think about. But when we get to next spring and everyone's looking at their tax returns, it's going to be a very different thing. So it'll be fascinating to see the impact people's investment habits as they see their tax bills.
On the supply side, we've had too many bonds. I mean, we're up a little bit in new money supply this year. But overall, supply is down compared to last year. But [supply] been increasing a little bit. But it's a question of how long [state and local governments] can hold out and not do infrastructure spending, because all of us see how much is needed all the time. It's not a secret. And some of it has to be paid for. And if the federal government doesn't get around to it, the states have to do something. So we could see some supply increase.
On the demand side, it's going to be interesting to see [how flows develop]. You see so money flowing into the short part of the market - all the short products are getting huge flows.
Investors are eventually going to realize, compared to the summer of 2016, we're up 150 basis pointsâ¦ [in] municipal bonds, the long end [of the curve] is up 1.5%. Your yields are that much higher. You take a tax equivalent [yield], you're talking more than a 2% advantage over where you were investing in 2016 when people were putting a lot of money into the long end of the market. So eventually there will be some comfort level with the stabilization of rates - hopefully.
Graham: Thank you, everyone, for your time today. Much appreciated. And thank you all for joining. Please join us on lordabbett.com for updates to our strategy and outlook. And we will see you next year.
For more on the 2019 investment outlook, please visit
A basis point is one one-hundredth of a percentage point.
FAANG is a popular acronym for five high-performing technology stocks: Facebook, Amazon, Apple, Netflix, and Google [now Alphabet, Inc.].)
Fed refers to the U.S. Federal Reserve.
The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Typically, an analyst uses the Treasury securities yield for the risk-free rate. The spread is added to the fixed-income security price to make the risk-free bond price the same as the bond.
Risk asset describes any financial security or instrument that is not a risk-free asset (i.e. a high-quality government bond). Risk assets generally encompass equities, commodities, property, and all areas of fixed income apart from high-quality sovereign bonds.
Yield is the annual interest received from a bond and is typically expressed as a percentage of the bond's market price. Spread is the difference in yield between two different investments. Tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond. This calculation can be used to fairly compare the yield of a tax- free bond to that of a taxable bond in order to see which bond has a higher applicable yield.
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