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Market View

In the third and final part of the series, Lord Abbett experts offer their views on prospects for fixed income and equity investments in the coming year.

 

In Brief

  • In the previous Market View, we outlined the macroeconomic factors that may influence markets in 2019.
  • Here, we conclude our roundtable with Lord Abbett investment leaders—representing a range of investment disciplines—with a discussion of prospects for key asset classes in 2019.
  • Our experts gave their outlook for U.S. taxable fixed income, U.S. equities, emerging market investments, and municipal bonds.

 

How should investors be thinking about key asset classes in the New Year? In this, the final installment of a special three-part Market View, we collect the thoughts of Lord Abbett experts representing a range of investment disciplines. (In the first part, we examined the factors that influenced market performance in 2018, and in the second, we looked at how the macroeconomic environment may evolve in 2019.)

In late November, we gathered a panel featuring Lord Abbett partners Giulio Martini, director of global asset allocation; Thomas O'Halloran, portfolio manager for micro-, small-, and large-cap growth strategies; Daniel Solender, director of tax-free fixed income; Leah Traub, portfolio manager for taxable fixed income; and Kewjin Yuoh, portfolio manager for taxable fixed income. The discussion was moderated by Joseph Graham, head of the firm’s investment strategy group.

Graham started the third and final segment of the roundtable discussion by asking the panelists for their thoughts on the 2019 outlook for major investment categories.

U.S. Taxable Fixed Income
Addressing the bond market, Martini said that yield spreads on U.S. high yield bonds versus U.S. Treasuries of comparable maturity had contracted in 2018 before widening out again late in the year. “In a benign economic environment, you could not only pick up the yield advantage in high yield,” which was around 6%, based on the representative Bloomberg Barclays U.S. High Yield Index, compared to U.S. Treasury yields around 3%. Also, said Martini, prices of high yield bonds could recover based on the potential for the yield spread to narrow in 2019.

Martini noted that yield spreads on investment-grade debt had also “widened out quite a bit” in the late-year volatility. “So in an environment where inflation stays close to 2%, where the economy just grows somewhere around 2% to 2.5%”—which, he said, “looks quite reasonable”—he thinks U.S. assets are “actually priced attractively” as the calendar turns to 2019.

Yuoh added that his investment team “feels good about taking opportunities within risk sectors” going into 2019. But he sounded one cautionary note: “One scenario that we're thinking about is the return of inflation. We'll be keeping an eye on that.”

U.S. Equities
After the late-year selloff, Martini believes that U.S. equities are also attractively priced. Corporate earnings growth in the United States was at 25%, year over year, in 2018, he noted. The forward price-to-earnings multiple, a widely followed valuation measure based on analysts’ earnings expectations, peaked at about 18.2 in September, and had moved under 16 by late November—below its long-term average of 16.2.

“So we're 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,” with the potential to offer percentage returns “in the high single digits.”

O'Halloran noted that growth equities entered “a corrective phase” late in the year, as a breakout to new highs in leading technology names was quickly undone. But, he expects that “growth will do well in 2019.” While he doesn’t expect U.S. economic growth to accelerate, he believes advances in technology will enable “a lot of great innovation” in the consumer and health care sectors, and in the technology industry. “So, I see a lot of companies that are going to grow at double-digit rates” or better, he added.

Emerging Markets
What about markets outside the United States? Our experts agreed that the wild card for non-U.S. markets in 2019 is the U.S. dollar, particularly for emerging markets. “I think the emerging markets are going to be at the whim of the dollar in some respects,” said Traub, as the U.S. currency likely will be influenced by the Fed’s policy path in 2019. “So I think volatility is definitely here to stay.” But Traub believes valuations have moved to reflect that volatility, so there may be chances for some recovery in emerging-market asset prices.

Martini sounded a similar note. If the Fed adopts a less aggressive tightening path, the dollar should not “rise much more than it already has, says Martini. (See Chart 1.) “And that, I think, would clear the way for a better environment for emerging market asset spreads as well as equities.”

 

Chart 1. In 2018, an Active Fed Led to U.S. Dollar Strength. 2019 May Be a Different Story
U.S. dollar index (DXY), January 1, 2018–December 13, 2018

Source: Bloomberg. “Fed” refers to the U.S. Federal Reserve.  Market expectations of rate hikes are based on fed funds futures data.
The information shown is for illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.  Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator or a guarantee of future results.

 

Municipal Bonds
Solender noted that retail investors, who make up the majority of the muni-bond market, remain “very concerned” about rising rates. This has reduced their demand for longer-dated munis and spurred buying in the shorter end of the market. To the surprise of many, Solender added, the muni yield curve steepened in 2018 even as the Treasury curve flattened, reflecting supply and demand dynamics across the spectrum of muni-bond owners.

What will his investment team look at in 2019? They will be eying the impact of the 2017 tax bill, as the residents of high-tax states will be filing their first full-year federal returns following the imposition of the $10,000 cap on state and local taxes. ”It will be fascinating to see the impact on people's investment decisions”—especially demand for tax-advantaged instruments like municipal bonds— “as they see their tax bills.” Changes in party control of state governorships and legislatures following the 2018 U.S. midterm elections likely will also have an impact on spending, and thus, muni-bond issuance, he says. Long-delayed infrastructure projects may eventually have to be funded with additional muni-bond issuance, according to Solender.

With yields much higher on many maturities within the muni-bond sector, Solender figures that “investors are eventually going to realize” the potential advantages of the asset class, especially when factoring in tax-equivalent yields. Solender expects that “eventually there will be some comfort level” for investors if interest rates stabilize in 2019, lending further appeal to muni bonds.

Looking Ahead
As a reminder, visitors to the 2019 Investment Outlook page can access a full range of content from the panel discussion. Market View will return on January 7 with a closer look at prospects for U.S. equities. 

 

MARKET VIEW PDFs


  Market View
  U.S. Market Monitor

Webinar Replay: 2019 Outlook
video
Listen to a replay of our Jan. 2 discussion with our investment leaders about their 2019 outlook for the economy, fixed income, and equities markets.

*Financial professionals only.

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