JANUARY 2019

What Will Shape the Markets in 2019: A Game of 20 Questions, Part III

Category: Investment Research, Portfolio Management

 By Doug Cohen, Managing Director, Portfolio Management

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.

This post is part three of a four-part series. The remaining questions can be read in parts one, two, and four.

11) Will crude prices reach the nearly $70 per barrel Wall Street consensus in 2019? 60% probability.

The dramatic 40% 4Q18 decline in WTI has turned sentiment overwhelmingly bearish amid fears of a worldwide demand slump and oversupply due to US shale, OPEC's inability/unwillingness to implement large supply cuts, and limitations to the sanctions that were originally expected to cripple Iranian supply. It may well take some time, but our sense is that OPEC, Canada, and many US shale producers will feel compelled to reduce supply if prices stay near current levels. Furthermore, we expect stabilizing demand and a somewhat weaker US dollar to enable crude prices to surpass $70 at some point this year. To the extent that plunging oil prices have been widely viewed as a harbinger of global economic weakness, we believe a V-shaped recovery from current levels would be a decidedly bullish economic indicator.

12) Will there be a so-called “hard Brexit” come March? 15% probability.

We have no doubt that political leaders are fully capable of taking difficult decisions right to the brink, but in this case we are reasonably confident they will not willingly preside over a needless economic catastrophe. The EU has every incentive to play hard ball to set a precedent that discourages other countries from leaving. In that sense, the UK and its seemingly weak political leadership (in both major parties) will likely need to make some painful compromises. In reality though, we think there’s a good chance that the UK calls for a second referendum, which could well result in a stay decision this time around.

13) Will the US housing market continue to slow in 2019? 70% probability.

Housing constitutes about 15% of US GDP so it clearly matters. Last year should have been a banner year for housing given robust 3% or so GDP growth, a 50 year low in unemployment, and a stock market that reached record levels as recently as September. Instead, the combination of rising mortgage rates, a lack of inventory, rising costs, a sharp reduction in foreign buyers and perhaps the new $10,000 state and local tax deduction cap left existing house starts in November with their largest annual decline in seven years. Overall single housing sales likely rose at a 4% or so pace for the full year versus 8% in 2017. While there are no signs of anything like the 2008 housing crisis, a flattish "soft landing" in 2019 seems most likely assuming that mortgage rates remain relatively steady.

14) Is there a corporate debt bubble poised to burst in 2019? 25% probability.

This is one of the most common concerns we hear from clients, particularly as it pertains to the lowest tier of investment grade bonds (including GE's approximate $110 billion in debt). To be sure, US investment grade debt has more than doubled to about $5 trillion since 2008, roughly half of it in the most speculative BBB+, BBB, and BBB- rungs. We are somewhat less concerned than the consensus, largely because we believe the fears of a near-term recession are overblown, but also because of weak recent issuance due to the 2017 tax changes (issuance was down about 12% last year). In sum, we are not overly bullish on corporate debt, but believe it would take a relatively deep and prolonged recession for rising defaults to morph into full-fledged financial crisis.

15) Will the US vacate its traditional role as the world's de facto policeman, exacerbating geopolitical risk?

To the extent this falls under the Rumsfeldian umbrella of "known unknowns", it is virtually impossible to offer a concrete probability. President Trump's periodic proclivity to de-emphasize traditional alliances could foment unrest in any number of ways—or not at all. What is clear though is that the markets have all but ignored occasional geopolitical instability in recent years. Could withdrawing troops from Syria embolden Iran and Russia to increase their presence? How would Israel respond? What happens if President Trump receives irrefutable evidence that North Korea is aggressively expanding its nuclear capabilities in violation of the recent detente? The number of hot spots is high, as always. However, how the US might respond to any particular situation has rarely been less predictable and it is certainly possible that markets will no longer be able to ignore the implications.

 

 

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