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Economic Outlook, April 2019
During the first quarter, market apprehension receded in the wake of the Federal Reserve’s December pivot to more dovish monetary policy. Investors set aside—or at least looked past—the anxieties that roiled financial markets in the fourth quarter. U.S. economic data remained positive overall, supported by business-friendly fiscal policy and a healthy consumer. Although many corporations issued more cautious guidance about future earnings in the first half 2019, markets focused on the string of strong earnings and revenue results being announced for the fourth quarter. Financial conditions improved dramatically after a December squeeze, and credit spreads tightened significantly. (Tighter spreads are a sign that corporate borrowers can issue debt more cheaply.) The global growth outlook improved, helped by a contained U.S. dollar, optimism about an eventual resolution to global trade disputes, and data supporting the view that China’s economy could achieve a soft landing.
Looking forward, we believe:
- The U.S. economy will extend its steady expansion through this year and beyond. The global economy is positioned for moderate growth, with a pickup in the second half of the year.
- The relatively weaker earnings season currently underway reflects a high bar in terms of year-over-year earnings growth, and we would not be surprised to see earnings growth pick up in the second half of the year.
- Investors should not grow complacent: Volatility and sideways moving markets will characterize this phase of the economic cycle, due to a wide range of entrenched global uncertainties.
- Although we see tailwinds for economic growth and opportunities across asset classes—including in growth equities, convertibles and high yield bonds—conditions require a highly selective approach.
- Given the crosscurrents in the economy and markets, risk-managed alternative strategies can provide timely enhancements for both the equity and fixed income sides of an asset allocation.
The U.S. economy is positioned for slow and steady expansion. As we have noted in our past commentaries, economic cycles should not be measured by their duration, but by fundamentals—and the fundamentals remain surprisingly compelling this long into an expansion. Energy prices and wages have risen, but inflation overall is benign. We expect healthy consumer activity to drive the economy, helped by wage growth, low unemployment and manageable debt levels. Broad financial conditions and liquidity have recovered after the fourth quarter’s tailspin. An accommodative Federal Reserve is likely to buoy U.S. economic growth and markets further, with positive knock-on effects globally.
Even though the initial boost of tax reform is in the rearview mirror, we believe that tax policies will still provide a sustained catalyst for the corporate sector, as will de-regulation. As we enter earnings season, we share the view that many corporations may be hard pressed to match or beat the earnings growth they posted a year ago. However, improving global conditions and continued steady growth in the U.S. could result in a reacceleration in earnings growth in the second half of the year, with positive growth for 2019 overall.
Although our U.S. economic outlook for these next quarters is constructive, this environment requires selectivity. We expect a stock picker’s market to prevail, rather than one in which a rising
tide will lift all boats. The brief inversion of the yield curve should not be viewed as a precursor of imminent recession, but it does indicate building pressure within the economy, which we are monitoring closely, along with other potential risks such as corporate debt levels, shifts in global central bank policies, and indications of tightening in consumer borrowing. Geopolitical and U.S. political uncertainties are formidable and will fuel periods of short-term volatility; in the U.S., these will increase sharply in the run up to the 2020 election.
At this phase of the cycle, attention to valuations and company fundamentals will be essential. An improving global economy provides a favorable backdrop for a number of growth companies, including those tied to U.S. and global consumer activity. Our teams continue to identify opportunities in the financial sector, where we see compelling valuations. We are also looking for companies that are capitalizing on disruptive trends.
Global and International Strategies
We believe the slowdown in global conditions over recent months has likely been a soft patch, and we would not be surprised to see stronger economic growth data in the second half of the year. Accommodative monetary policy from global central banks, a contained dollar, and modest growth in the U.S. sets up well for non-U.S. markets. We expect the U.S. and China to reach a trade deal, and while this may not be the deal to end all deals, it would remove a key uncertainty. Regardless, economic conditions in China are improving, with consumer-focused stimulus, de-regulation and easing liquidity conditions sowing the field for green shoots.
In Europe, there are still many formidable headwinds—political uncertainty, social discontent and challenging fiscal policy. Even so, conditions are unlikely to get much worse. Given their close economic relationship, improved growth coming out of China could provide a welcomed boost to Europe, although as we have noted in the past, the impact may be tempered by the domestic bias of China’s consumer focused stimulus.
We expect to see more convergence among growth rates globally, and this “re-synchronization” of global growth should be positive for risk assets, including emerging market equities where valuations are compelling on the whole (Figure 3). From a regional perspective, we are favoring China, India, and Brazil. In Europe, our positioning is largely in global secular growth opportunities and in some cases, more regional businesses with stable, less-cyclical growth characteristics.
Our global and international strategies reflect a bias toward higher quality growth businesses, which served us in good stead during the quarter, as market sentiment pivoted to a more fundamentally oriented trading environment. We have emphasized companies that can benefit from consumer activity—the more robust segment of the global economy and the linchpin of many of the long-term
secular growth trends we favor. At the margin, we have been reducing our exposure to more defensive sectors given the strong performance of many of these positions during the past few quarters, which has resulted in less attractive risk/reward profiles.
John P. Calamos, Sr. Is Founder, Chairman and Global CIO of Calamos Investments.