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John Engle
John Engle
Articles (406) 

Economic Policy May Drive Stocks in 2019

E-Trade offers its market forecast for the new year

January 21, 2019 | About:

With 2018 in the rearview mirror, investors are actively asking: What should we expect in 2019?

There are many answers to that question, courtesy of the countless analysts, research houses and commentators offering their forecasts for the new year. Analysts at E-Trade Financial Corp. (NASDAQ:ETFC) recently offered their take, highlighting a number of themes they expect to define the market in 2019. These are issues well worth keeping in mind as the new year takes shape.

Trade war elevates uncertainty

The global economy is an extremely complex beast, but there are a few key elements that could have outsized impact on global growth in 2019. The continuing trade war between the U.S. and China could have monumental impacts on the global economy, as E-Trade’s forecast highlights:

“Over the past year, the Trump administration has slapped more than $250 billion in tariffs on China alone, but the administration has also targeted steel, aluminum, solar panels and appliances imported from other countries. Who is winning the trade war? Many economists would say no one, since tariffs increase the price of imports and can be an impediment to economic growth.”

In reality, there are no winners in a trade war. Not really, anyway. All sides ultimately lose out in aggregate as the costs of goods and services rise in response to retaliatory action and market uncertainty. While negotiations are continuing, the trade war is far from over. So long as the world trade order is under threat, uncertainty and volatility will be elevated.

Fed policy moves the economy

The Federal Reserve has been in the spotlight for the last several weeks, with the final rate hike in 2018 spooking the market to a high degree. As E-Trade’s 2019 outlook points out, there are a number of factors that could embolden or limit the Fed’s actions during the year:

“The Federal Reserve has lifted short-term interest rates three times this year but has hinted at slowing the pace of monetary tightening as rates move closer to neutral. Consumer price inflation hasn’t risen significantly of late, but it is running at the Fed’s target rate of 2%. Until inflation moves lower, the Fed could continue to raise rates...Could higher rates inhibit economic growth? Keep in mind that the Fed is tasked with promoting maximum employment and keeping prices stable; economic growth isn’t among its mandates...A more normalized rate environment could provide the Fed with additional dry powder to expand monetary policy by lowering interest rates if needed.”

While the central bank had previously been adamant in staying the course, Chairman Jerome Powell has softened his tone lately in light of the unexpectedly violent market reaction to tightening. Whether Fed policy softens or moderates in 2019 will be a major determinant of the market’s behavior throughout the year.

Watch that yield curve

With economic policy, both foreign and domestic, in a state of unusual flux, the risks of something setting off an economic and market correction are elevated significantly. As E-Trade’s report points out, it is wise in such times to pay close attention to the yield curve:

Investors remain concerned about the flattening yield curve, as an inverted yield curve can signal that a recession is on the horizon. Recently, parts of the short end of the curve have, in fact, inverted. However, there are two important caveats: First, parts of the yield curve do invert from time to time, and the most-watched portion between 2- and 10-year Treasuries is not inverted at the time of this writing. Second, even in times of a more pronounced curve inversion, a recession is typically one to two years off.”

Yield curve inversion has been a tell-tale sign of impending recession in the past, but should we worry about it now? After all, the current market has defied expectations before and policymakers are moving about in somewhat uncharted territory. Still, we would hazard that the worrying signs from the yield curve should still be taken seriously. It is not clear whether a full-blown recession is imminent, but there are definitely mounting signs of potential trouble. Investors should be on their toes.

Verdict

With all this strangeness in policy, as well as signs of concern throughout the domestic and global economies, investors would be wise to go cautiously into 2019. That does not mean going totally on the defense, but it would be wise to act with greater caution and deliberateness in the months ahead.

For value investors, prudence is always a watchword. It should be even more so now.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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