Economy and investment strategies in 2019

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Recession unlikely and an eventual increase in stock prices

Economy: Despite the recent flattening of the yield curve and the drop in stock prices last quarter, we estimate that the likelihood of seeing the U.S. economy sink into a recession in 2019-2020 is less than 25%. Strong economic fundamentals, combined with expansionist fiscal policy and far from restrictive monetary policy, should pave the way to prolonged U.S. business expansion and above-trend growth in 2019 (2.4% compared to 3.0% in 2018). Regarding the global economy, a deceleration of economic growth (around 3.3% in 2019 compared to a projected 3.7% in 2018) is likely given the deceleration underway in China and geopolitical uncertainties (Brexit in Europe, tension between the White House and the Democrat-led Congress).

Interest rates: Due to the recent tightening of financial conditions (drop in equities and corporate bonds), the Federal Reserve (Fed) should take a pause in the first half of 2019, even more so as its current leading rate has moved back into the “neutral” zone and inflationary pressures remain muted. The Bank of Canada should be more active given the delay in its interest rate normalization process.

Bonds: The Fed’s “wait and see” attitude should pave the way for a more “risk-on” mood. In such circumstances, high-yield corporate bonds and emerging market bonds are now more attractive than the same time last year for investors with a higher risk tolerance.

Stock markets: Assuming there are positive developments in negotiations with China and a more pragmatic Fed, the significant volatility observed since early October should gradually reduce in the first half of 2019. History has shown that in the absence of a recession, Wall Street should recover a significant portion of the recorded losses (‐19.8% since its peak) within a reasonable period (between 9 and 12 months).

Currencies: With the Fed temporarily taking to the sidelines and given the scope of budget and foreign imbalances (close to 8% of the U.S. GDP), downward pressure on the greenback should gradually increase in 2019. At the same time, the Canadian dollar should rebound closer to 80 cents U.S., even more so because the Bank of Canada should continue to normalize its rates.

Investment strategies: In the absence of a recession, equities should outperform government bonds in 2019. At current valuation levels, the Canadian and overseas markets (emerging markets) offer a better risk‐return ratio than the U.S. market.