The Santa Claus rally arrived late this past year but finally came through in a big way and has carried forward into the New Year. Positive news, with a more dovish Fed and face-to-face talks with China on trade issues, has supported this recent rally. While this has raised investor spirits, the damage done over the 4th quarter of 2018 was substantial and the type of sell-off we experienced is not typically reversed overnight. We would expect volatility to remain fairly elevated for the first half of the year as we go through what we feel could be a bottoming process in the equity markets. In spite of the rally we have seen to start the year, there is still a possibility stocks retest their old lows before starting what could be the next leg up in a secular bull market. With this in mind, we return to the underlying fundamentals of the economy and corporate earnings to guide us in our 2019 outlook.
Relative to 2018, it is a foregone conclusion that corporate earnings growth will slow in 2019 as the 20% plus growth we experienced this past year was largely subsidized with the cut in the corporate tax rate providing a year over year boost. In the coming year, our expectation is we will see corporate earnings growth in the mid to high single digits. While at a slower rate, it is important to understand we still expect earnings to grow even as the economy itself slows from the increased interest rates implemented by the Federal Reserve this past year. This can still result in a positive environment for U.S. equities as long as the slowdown does not develop into a recession. We do not see indicators at this point to suggest we are anywhere near a recession for the coming year.
One change we have made to our portfolios was to remove the currency hedge we have had in place for our international exposure. With the U.S. economy far outpacing the rest of the world this past year and the Federal Reserve raising interest rates, we had been positive on the dollar relative to other currencies and had hedged our holdings in other countries. As we see the economy slowing and hear the Feds comments about patience in their approach to raising rates, we expect the dollar may weaken this year and the hedge is no longer warranted.
Also, with a slowing economy and slower earnings growth for U.S. companies, we are making certain changes to the asset allocation for our strategic portfolios. As domestic earnings growth slows, we expect international growth rates to begin looking more attractive on a relative basis. Because international markets significantly underperformed the U.S. markets last year bringing valuations down, many individual companies and country markets are looking more interesting. In addition, while the China trade issues will be a multi-year challenge, we expect some progress will be made which could ease tariff pressures affecting international markets. Where we remain somewhat cautious on developed international markets, emerging market securities stand out as attractively valued especially with their normally higher growth rates. We are looking to increase our exposure to those markets to take advantage of what is shaping up to be a particularly good environment for this segment.
On the fixed income side, a slowing economy with a Fed indicating a pause in raising rates has given us more confidence in lengthening the duration of our portfolios. We have held very short maturities in our taxable bond portfolios as those 1-2 year rates have been relatively attractive versus those offered on longer-term bonds. With the expectation rate tightening may be on hold, we feel that extending our maturities will provide a better return for the coming year.
While these actions in our portfolios will better position us for the outlook we have put forth for the coming year, our process is built on diversification thereby lowering risk for our clients. With that in mind, we are introducing real assets to our strategic portfolios. Our near-term outlook is not inflationary, but there are various dynamics we see that can ultimately result in more upward pressure on prices. The low unemployment rate and a more populist environment has translated into the highest wage growth the U.S. has experienced in a decade. In addition, in spite of the slower pace of growth we are forecasting, our longer-term outlook remains positive as we see the benefits of less regulation and lower tax rates domestically. Globally, as trade issues get resolved and political headwinds abate, growing demand for various commodities should ultimately outstrip current supplies. Initial exposure will not be large but will access those areas expected to benefit as structural shortages provide opportunities.
Finally, our tactical portfolios continue to hold a significant amount of cash. After protecting against some of the market’s decline in the fourth quarter, we continue to hold this dry powder until we see further confirmation that the market has bottomed and established a more defined uptrend.
In summary, we remain positive on U.S. equities as well as emerging market equities for the coming 12-18 months. We expect near-term volatility will eventually give way to the underlying earnings growth that ultimately driving stock prices higher. Current valuations are reasonable based on historical measures especially when compared to other asset classes. While short term interest rates have increased over the past year, longer-term rates are still relatively low so we prefer to stay defensive in our exposure to the fixed income markets. Our balanced portfolios have held up well through the recent market turmoil and we feel are positioned well for the coming year.
We welcome your feedback and look forward to meeting with you in the coming months. We sincerely wish you and your families a happy and prosperous 2019.
– Syntal Investment Team