2019 Market Outlook

We write this 2019 Market Outlook in a very particular market context. U.S. equity averages suffered one of the worst months of December on record, with the S&P 500 down more than -20% from highs. Ostensibly, the Federal Reserve has turned hostile and the global Trade War is far from being resolved. Biased by the equity market sell-off, the vast majority of commentators are now calling for a deep Bear Market and recession. Equity sentiment indicators are at the lowest levels since the Great Financial Crisis. It’s easy to give in to the pessimism, especially if one believes that selling is justifiable based on extreme valuations resulting from nine years of zero interest rate policy (ZIRP) and quantitative easing (QE). However, selling into a 500-point drop in the S&P 500 in Q4, on little change in economic or corporate fundamentals, is essentially giving into one’s emotions. And we already know that professional traders and algorithmic traders make their living of off taking money from the “weak hands” (retail and individual investors). High frequency trading and inverse algos are making their market in the stock trade. However, if we are indeed in a long-duration Bear Market in U.S. equities, lots will happen before the ultimate equity market bottom is put in, perhaps not until 2020. The Trade War will be resolved, more company share buy-backs will occur, and the Fed will reverse course, ending quantitative tightening (QT), providing a short-term leg higher in equities. Perhaps even the U.S. president will be impeached and removed from office. In sum, equities markets could see a series of powerful moves in either direction from this point. Investors must avoid being dogmatic in 2019, keeping an open mind and remaining attentive to indicators of economic strength.

Forecasting how 2019 will play out may be pure guess work under the current circumstances. As we begin the year, there is a shut-down of important U.S. government services and Trump’s political fate (now in the hands of a Democratic Congress) is even up in the air. Military conflict seems inevitable in the Middle East, the end of the tariff war is not yet in sight, most market participants are calling for a recession, Federal Reserve policy seems confused, and OPEC production cuts may be forthcoming, just to name a few of the uncertainties. With that caveat, here is our current vision of what may play out on markets in 2019.

I. 2018 Market Review

As we say good-bye to 2018, we believe that the year will most be remembered for marking the end of one of the greatest Bull runs in U.S. equity history. Surely the unconventional behavior of U.S. President Donald Trump will also be instilled in financial market history. From claiming credit for pushing the equity bubble to its peak (remember Trump’s boast, “how are everyone’s 401k doing?” during the January stock run-up), to his pre-announcing U.S. monthly Non-Farm Payrolls data on Twitter, to his Trade War (which, unless one believes Trump, is now hurting U.S. and international stocks and the global economy), and finally to his rage against the machine (the Federal Reserve), overtly criticizing the Fed for rate hikes and calling for the ouster of his own selection, Jerome Powell, as Fed chair. We saw U.S. long rates finally rise, with the 10-Year T-Note yield above 3.20%, before swiftly coming down as fears of an inverting yield curve and recession seized market participants.

Our 2018 calls from last December 2017 were not too far off the mark. For equities, we were distrustful of the U.S. market, as we wrote, “While betting on the U.S. equity market is the status quo allocation decision, the risk/reward ratio for the trade gets less attractive each day. Our main concern is the degree of speculation in the market. Maybe the U.S. economy reaches 6% annual GDP growth and earnings justify the valuations urrently attached to stock prices. But the onus is now on the speculators. If the scenario imagined by those piling into U.S. stocks today does not completely materialize, equity prices will come down fast.”

Although U.S. equities did continue higher through the 3rd quarter, the 4th quarter Bear Market proved us right before the close of the year. We were also very cautious on Europe and Japan, “developed equity markets we would avoid”. The DJ Stoxx 600 finish 2018 down -13.6% while the Nikkei was down 12.2%.

We liked Emerging Markets for their undervaluation and relatively under-owned status. EM markets will finish the year down about -16%. We were too early with the EM call, but still believe global equity leadership will swing from the U.S. to less-inflated EM stocks (as detailed in the Equity section below).

Our rate outlook was spot on. We wrote, “…in this context, we expected the U.S. 10-year yield to at least hit 3.0% in 2018”. We also expressed an interest for EM bonds last December. Local currencies EM bond price indexes finished the year down about -13% while hard currency EM bond indexes were down -11%. Adding back the 6% annual dividend, EM bonds still proved to be a better bet than most equites classes for the full year.

On currency markets, we expected short-term Dollar strength on the Trump tax cuts, which we advised selling into. The Dollar Index indeed gained in the first half of 2018, but the Dollar has thus far held onto these gains. The Dollar Index is set to finish the year up over +6%.

On commodity markets, our oil price forecast (“for 2018, we anticipate WTI to average $65 within a range of $55 to $75”) looked good until the fourth quarter. We saw gold reaching $1400/oz in 2018, which proved to be too ambitious given the firmness of the dollar. Gold traded briefly above $1350 earlier in the year, but came off in Q3, although the yellow metal is returning to $1300 as we close out the year.

II. Macroeconomic Outlook 2019

The U.S. economic expansion is entering its 10th year, making the recovery which began in 2009 the second longest on record. On one hand, we want to keep an eye on the exit door. On the other hand, speculating on the end of a late-cycle economic expansion can leave your portfolio mis-positioned should the expansion drag on.

Among the most reliable economic indicators, including the ISM PMI, other regional business survey data, and the Leading Economic Indicators (LEIs), any calls for an impending recession are crystal ball, speculative  guesses. This is not to say these guesses may not be right, but rather the “writing is not yet on the wall” for an  impending recession in 2019.

Both the Manufacturing and Service ISM PMIs have yet to break-down.

We have never seen the S&P 500 down on a year-to-year basis without the ISM PMI moving into contraction (below 50).

The Index of Leading Economic Indicators (LEI) is also holding up, for now. The LEIs is an index of economic indicators compiled by the Conference Board. These variables have a good track record of predicting economic downturns (although they have also falsely predicted some downturns which did not occur). Looking back, however, we have never had a significant economic slowdown without the year-on-year change in the LEIs going negative. The ten forward-looking variables in the index include items such as unemployment claims, manufacturing shipments and orders, housing starts, interest rate spreads, M2 money supply, PMI indexes, the S&P 500, and consumer sentiment. We are quick to point out the stocks are themselves a leading indicator for the economy. As such, the plunge in stock prices has brought out many calls for recession. However, the overall LEI index has yet to turn down. The chart below shows the year-on-year change on the LEI.

We looked at the lead/lag times from when the year-on-year change on the LEI went negative and the date the NBER declared the official beginning to a recession. Our findings are shown in the table below.

Given this track record of the LEIs, we won’t join the crowd, which is squawking about how the sky is falling and recession is imminent. Astute readers will recall that the S&P 500 itself peaks, on average, about 9 months before the economy enters into recession (we have written about this in prior Commentaries). To go a step further, here are the historic lead times of the S&P 500 peak versus the LEIs.

For predicting the S&P 500 top, the LEIs are not as reliable. Nonetheless, Bear Markets associated with recessions are much more severe. In this sense, bailing out of risk assets prior to getting an indication from the LEIs of recession is again speculative guess work.

One hypothesis we are currently entertaining is that the S&P 500 may just be plunging because of ridiculous valuations, not because an economic recession is imminent. If this hypothesis proves to be true, those now positioned for a prolonged Bear Market and recession starting in 2019 will end up chasing prices higher.

On the employment front, we now have a tightening labor market with unemployment now down to 3.7%. Unemployment may continue to hold at these low levels in 2019, but unemployment is the ultimate rear-view mirror indicator. Nonetheless, as long as the U.S. economy is at full employment, we don’t expect the Fed to get overly dovish in the new year (barring a combination of deflation and crashing asset prices).

Sentiment numbers from consumers and business are tracking at historic highs. Perhaps the mini stock market crash in December will cool off sentiment going into 2019. Consumer spending will be crucial to keep the economic expansion afloat, so we’ll be watching the retailers more closely.

As for U.S. GDP growth, we project a growth slowdown in 2019 as the fiscal policy sugar high wears off and Fed interest rates begin to bite. We do not foresee negative GDP growth but are clearly less optimistic than the Fed (central tendency GDP from 2.4% to 2.7% in 2019) and most economists on the Street. Our projection is shown in red (1% to 2% GDP growth for the year). 2019 may bring a growth scare which ensures that U.S. equities remain well below 2018 highs. The current U.S. expansion will become the longest on record, if it lasts until July 2019. Given the propensity for record-breaking financial market activity over the past few years, we would not bet on a recession beginning before Q3 2019.

In other developed markets, we don’t expect Japan and Europe to grow faster than the U.S. in 2019. Eurozone GDP slipped to 0.2% in Q3 (Germany actually contracted, -0.2%), down from 0.7% at the end of Q4 2017  (non-annualized figures). Signs of export weakness are hampering the German economic machine, whileItalian budget tensions with the EU remain a concern. Japanese GDP actually contracted in Q3, -1.2%. World Bank 2019 GDP forecasts for Japan (0.8% from 1.0% in 2018) and for Europe (1.7% from 2.1% in 2018) suggest a continued slowing of growth. The surprise may come from GDP growth rates exceeding the current pessimistic expectations.

China’s economy is suffering. Year-on-year GDP growth slowed to +6.5% in Q3 – the slowest rate since the Great Financial Crisis. A hard-landing seems to be the consensus view. The Chinese stock market appears to be reflecting this. Yet China is committed to rebalancing its economy, emphasizing consumption and services over exports. Debt reduction is also a priority. Any investment in China at this point are bets that the hardlanding does not play out (a bet we would take). One scenario we would not dismiss is the People’s Bank of China (PBOC) taking a page out of the Fed’s playbook in 2019. The PBOC may indeed decide to massively print liquidity to end the economic growth skid. Coupled with a resolution to the Trade War, we would see China enjoy a soft-landing that investors will love.

III. Bond & Yield Forecasts

The gap between Central Bank policies widened in 2018. The Federal Reserve proceeded with four one-quarter point rate hikes as other major world Central Banks maintained crisis-level monetary policy measures. We do not believe that the Fed is making an error with this cycle of rate hikes. The Fed’s error was leaving rates at 0% for nine years. We are just paying the price for that extraordinary monetary policy error. The current rate tightening cycle should have begun in 2012. Now we have to deal with at least five years of asset price distortion.

Our forecast for Fed rate hikes is simple: we have seen the last rate hike in this cycle. The next Fed Funds move will be a rate cut, if indeed U.S. growth has peaked and the equity Bear Market persists. Fed economists are not very real-world savvy, but we cannot see them sticking to the current plan for two more hikes in 2019, in the face of decelerating growth and financial market turbulence.

The persistent Fed rates hikes have pulled up the short end of the Treasury yield curve. Growth fears from “peak earnings”, an on-going Trade War, and collapsing oil prices have pulled down the long end of the curve. The result is a further flattening of the 10/2 Treasury yield curve, which we have been highlighting frequently. On a closing basis, the spread got down to just +2 bp in December. This is the greatest risk to our economic forecast. Our thinking is that the heavy interest rate manipulation by Central Banks may have “thrown off” this recession indicator a bit. If the Fed continues to raise rates, contrary to our belief, and the long-end does not move up, investors will start to seriously price in a true recession risk. We won’t be dogmatic here if the 10-2 curve inverts in 2019, LEIs turn down and the ISM PMIs roll over, we’ll start our count-down to the nextrecession.

Developed market foreign bonds seem still very expensive. We would under-weight/avoid Bunds, JGBs and Gilts. U.S. Treasury yields remain exceptionally low for this stage of an economic expansion. However, as the Fed ends its rate tightening cycle, fixed income money that went overseas may move back into U.S. Treasurys, which tend to perform well during periods of equity volatility – irrespective of the direction of rates prior to financial market volatility. 2018 is just the most recent example (10-Year yields traded above 3.2% before coming down to 2.7% in December).

We would avoid credit in 2019. Twelve years ago, consumers refinanced home mortgages and borrowed against the (rising) value of their properties to buy big ticket items. Now it is corporations using cheap debt and the one-time Trump tax-cut windfall to take cash from balance sheets to pay shareholders in the form of dividends and share buybacks. The cash-outs have driven corporate debt to record levels.

According to Federal Reserve data, Outstanding Debt by Corporate Sector hit $15.38 trillion at the end of Q2 2018. Or, as a percent of real GDP, 50.9% (green line in chart below). The blue line shows the bust in household debt following the Subprime Crisis, which never recovered relative to GDP during this economic expansion.

We therefore would NOT chase yield in corporate paper in 2019. The iBoxx Investment Grade Corporate Bond ETF (LQD) and the Barclays High Yield Bond ETF (JNK) look excessively dangerous in light of the corporate debt bubble.

As mentioned, investing in Treasurys at 2.7% for 10-year maturities is hardly enticing as the economic growth peaks. We prefer turning to Emerging Market sovereign bonds in these exceptional market conditions. The first reason is for the yield pick-up. EM local currency bond indexes pay roughly 6.5% annual yields. We believe that the positive spread over Treasurys is worth the extra volatility. Emerging Market assets in general have been neglected during the Bull Market which began in 2009. Lots of the concerns over trade, rising U.S. interest rates, and sub-par growth are now fully reflected in prices.

The second reason we like local currency Emerging Market bonds is for the currency diversification out of dollars and into cheap emerging currencies. As we show in the next section, our favourite currencies for 2019 are mainly in Emerging Markets.

IV. Currency Market Outlook

We have a preference for under-valued currencies going into 2019. It is possible that the death of the U.S. momentum trade on equity markets may carry over to the currency market. If U.S. equities underperform in the next stock market cycle, the long-term down-trend in the Dollar Index should resume.

The Fed’s tightening cycle is well is advance of those of other world central banks. The Dollar Index reflects this monetary policy lead. For the Dollar to continue to rise, we’ll need to see the Fed carry though with at least two rate hikes in 2019, the U.S. economy perform better than expected (and other developed nations have disappointing growth), and foreign central banks carry on with their crisis-level monetary policies. This is too much to ask for. We are Dollar bears.

Among developed currencies, we like the Japanese Yen. The Yen could receive tailwinds as the Bank of Japan (BoJ) gets less dovish. Moreover, Yen sentiment is overly negative and extreme levels of short Yen positions will have to be unwound should the risk-off trade pick up stream. Remember that the Yen is a risk-off currency. In the chart below, a falling curve indicates Yen strength (fewer Yen to buy $1).

We are mildly bullish on the euro, which appears undervalued at these levels and should receive support as the improving economic indicators in Europe will allow the European Central Bank to move away from crisis monetary policy rates. Sterling is a wild card. GBP will swing wildly as Brexit negotiations advance.

Our preference remains for Emerging Market currencies, which have underperformed with other EM assets during most of the expansion which began in 2009.

The first currency we like is the Philippines Peso. The Philippines GDP growth remained at a robust 6.1% in Q3 2018 and has held about 5% each quarter since 2011. Underperformance of the Peso seems unrelated to the country’s economic fundamentals (manufacturing PMI showing strong expansion at 54.2, Building Permits at 18-year high, exports are expanding strongly). When political risks fade, national currencies tend to appreciate quickly.

The chart of the Peso below also looks attractive, as the currency traded down to 2005 lows this past quarter against the dollar. Again, a falling curve indicates Peso strength (fewer Pesos to buy $1). We cannot be sure that 2019 will see a major rally in the Peso, but after a -35% fall since 2013, risk is clearly to the upside.

Staying in the Southeast Asian region, we also like the Malaysian Ringgit and the Indonesian Rupiah, both trading near cycle lows.

The Ringgit rallied to highs of MYR 2.9 following the Financial Crisis. However, since 2013, it has been ugly (Ringgit down around -50%). Growth has been decent (GDP in 4.5% to 6.5% range in this expansion) but the currency has been hurt by the high foreign ownership of Malaysia’s government bond market, which leaves the country extremely vulnerable to capital outflows. In addition, the central bank’s recent move to clamp down on currency speculators probably rattled foreign investors further in 2016. All these reasons are old news. We see a currency trading not far from cycle lows, more exposed to positive surprises than additional negative events. For investors looking to diversify a bit out of the U.S. dollar, we recommend allocating a bit to MYR. In the chart below, a falling curve indicates Ringgit strength (fewer Ringgit to buy $1).

The Indonesian Rupiah has suffered from the country’s high current account deficit. The high foreignownership of bonds coupled with Indonesian corporates’ increased USD debt are also rendered the Rupiah prone to weakness. Like the Ringgit, our bet on the Rupiah is that the bad news has been priced in and any positive news can kick off a return-to-the-mean trade. In the chart below, a falling curve indicates Rupiah strength (fewer Rupiah to buy $1).

Among Latin American currencies, we like the Brazilian Real. Brazil is moving towards economic improvement. Jair Bolsonaro, the new Brazilian president, will begin his term on January 1. He is pro-market and will try to tackle the mounting debt load in Brazil (debt-to-GDP hovering near 75%). Unlike his socialist predecessors, he is open to privatization. The Real halted its down-trend on news on Bolsonaro’s election.

The chart of the Real is more than compelling. With the Real trading again down to BRL 4.0 / USD in 2018, the currency is putting in a potentially major, multi-year double bottom (or, as the chart below shows, a double top for the U.S. Dollar vs the Real).

Finally, we have been playing the Turkish Lira since the currency crashed in August. A return to rising trend support from 2015-2017, now around TRY 2.25, seems probable in 2019 as some form of normalcy returns. That’s another +20% upside for the Lira. In the chart below, a falling curve indicates Lira strength (fewer Lira to buy $1).

V. Commodities Markets Perspectives

We have written in length about the Commodity trade (see “The Commodity Super Cycle”). In sum, our arguments are as follows:

• Commodities (oil and metals prices) should be at their sweet spot in the late economic cycle. Inflation tends to pick up as the economy begins to overheat. And commodity prices tend to be one of the best inflation hedges.
• Relative underperformance of hard assets compared to stocks has reached a 20-year extreme. The pendulum will swing back in the direction of hard assets, just as we have observed throughout history. 
• Commodity stocks are unloved and under-owned. The weight of Energy within the S&P 500 is below 5% — an all-time low. When sentiment gets this sour, its best to be contrarian.

The recent collapse in oil prices does not change our thinking, as the drop in crude oil does not reflect fundamentals but rather (1) excessive speculation over a global economic slowdown and (2) a rapid unwinding of long crude/short Nat Gas trades put on by large hedge funds. We trust OPEC will manage supply to keep oil prices at stable levels, higher than levels prevailing today. As for global oil demand, this mostly depends on the economy of China and the monetary policies of the People’s Bank of China. Commodity investors should be particularly attentive to a Chinese economy hard or soft landing.

Looking at the S&P 500 relative to the Philadelphia Gold & Silver Index, we see that precious metals are historically very cheap compared to stocks. An allocation to Gold and the Gold Miners also makes sense for 2019 as a hedge against a Fed monetary policy error, Dollar weakness, and late expansion inflationary pressures.

VI. Equity Market Outlook

Higher interest rates in the U.S. and less accommodative monetary policies from major central banks will reduce liquidity on financial markets. The result will be higher volatility on equity markets in 2019. The slow, grinding low volatility equity up-trend that characterized 2017 seems definitively finished. Global economic growth is likely to become less synchronized and more fragmented. Country allocation will be critical. Successfully navigating financial markets in 2019 will take greater skill than just continuing to invest in index fund products. In sum, no investment style works forever and we believe the return to active security selection will be the key to running a successful portfolio in 2019.

Investors’ expectations for returns need to come down in 2019. Global risk asset returns have far out-paced economic growth and long-term averages since the Financial Crisis. The tailwind provided by Central Bank is dissipating. Trade and geopolitics will be a sideshow again in 2019 (nice reasons for media to explain falling equity prices). In reality, we know that liquidity moves markets. When the Fed recognizes (hopefully sooner than later) that raising rates and withdrawing liquidity will tank the stock market and plunge the economy into recession, we can hope for a durable up-cycle (even if October 2018 highs prove to be the Bull Market top).

We present our preferred equity investment themes below.

Value over Growth. Cyclical growth companies have blown away all other investment styles in recent years. The gig is up, in case you missed the Q4 2018 wake-up call. For 2019 we prefer less-cyclical companies that deliver consistent earnings growth. This does not necessarily imply a sector bias, as even some Tech companies may also fit the bill.

Looking at the ratio of the Russell Growth to Russell Value Index, we can see just how exaggerated the Growth trade has gotten. For U.S. equity allocations, we are turning decidedly negative on Growth for 2019. We already warned back in our December 6 Commentary to avoid high PEG Growth stocks (the Nasdaq fell over -15% since publication). Moreover, the indexes are now dominated by Growth stocks which have doubled or tripled the performance of traditional Value stocks over the past years. This implies that passive index investing – taking on exposure to high PEG Growth stocks – is not the path to take in 2019.

Bill Cara is arguing that not all companies are trading at extreme valuations. A glass-half-full approach suggests that valuations could simply be higher than average and consistent with the strong global economy. The top 20 U.S. companies (average market cap = $364B) have a PE of 24.2 and a Forward PE of 16.8.

If Amazon (AMZN) is removed, the rest have an average PE of 20.7 and Forward PE 14.8. That is not extreme. Of course, this all depends on the accuracy of earnings forecasts and a continuation of healthy economic conditions. If the U.S. economy begins slowing to the degree we expect, all bets are off.

From a fundamentals perspective, we expect positive, yet decelerating revenue and earnings growth. Historically, earnings recessions tend to start up to 12-months after the yield curve inverts. Clearly it is not  time to panic. Consumer-oriented companies (XRT) will serve as a leading indicator to a broader earnings recession.

As for sector allocation, we continue to favor late-cycle plays, notably Energy and Basic Materials. Our September 28 Commentary summarizes our argument for Energy stocks. Oil Exploration & Production stocks (XOP) are likely experiencing what we saw with all risk assets in February 2009. While we got into the XOP and various oil names too early in 2018, those who bought the S&P 500 in December 2008 are not complaining today.

The Energy and Basic Materials sectors are the only areas of the U.S. market that we are taking a buy/hold approach to at this stage. While all Natural Resource funds are down big in the fourth quarter, there is nothing to do except forget about the investment and wait. Our Natural Resources selection has done well vis-à-vis the North America Natural Resources Index and especially well relative to active managers who tried to time a bottom in Energy stocks, exited on price weakness, then will buy back after prices rise.

In terms of global equity allocation, we are bullish on several Asian and Latin American markets. Our main interest in EM markets is due to their underperformance during the stock cycle which began in 2009.

Big picture, Emerging Markets have suffered, in relative terms, one of their worst periods. The chart below shows the MSCI Emerging Markets Index relative to the S&P 500. We are talking -65% underperformance versus the S&P 500 since 2011. In the 1990’s Bull Market, the S&P 500 blow away EM. In the Tech Bubble burst and 2002-2007 Bull Market, it was EM stocks that dominated. During the Fed Bubble (2011-2018), U.S. stocks again blew away EM stocks. We guess that this pattern will continue over the next cycle, this time again in favour of EM stocks.

In addition to being under-owned relative to U.S. equities, Emerging Markets will not have to deal directly with the fall-out of years on inappropriate monetary policy in developed nations. The potential headwinds for the EM trade in 2019 will be a prolongation of the trade wars, slowing growth in China and dollar strength.

The Emerging Markets we will specifically look to overweight in 2019 are Brazil, Colombia, the Southeast Asian markets, China, and Turkey.

As mentioned, Jair Bolsonaro, the new Brazilian president, has brought some relief to Brazilian financial assets. Brazilian equities have already begun out-performing world equites on the prospects of reform.

The Bovespa is trading at a forward P/E 13.27x, at the low end of its historical range. For dollar-based investors, using the MSCI Brazil tracker (EWZ) gives additional exposure to the Real, which we also like.

Colombia is another Lat Am market trading at attractive valuations (11.89x forward earnings) and has been decorrelated from QE-juiced U.S., European, and Japanese markets.

The Asian trade will be impacted by numerous factors in 2019. Global trade plays an important role in these export-oriented economies. A resolution to the Trade War will help Asian stocks more than US stocks. Next, Fed rate hikes impact part of Asia as much as the U.S. Many Asian central banks (such as the Hong Kong Monetary Authority) are forced to raise rates along with the Fed… even if their economies are not needing tighter policy. If the Fed ends rate hikes here, this can only be positive for Asian stocks. A third factor which will impact Asian stocks is oil prices. High oil prices are both a drag on consumption and reduce dollar liquidity in Asian markets. Unless oil prices get back above $80/barrel, however, we don’t see oil prices as a major headwind for Asian stocks.

Indonesia is on our country allocation list for 2019. Jakarta trades at 16.53x forward earnings and may be getting a bit pricy relative to other EM markets. We won’t hold Indonesia if a lower low is put in on the Jakarta Index during 2019. We invest in Indonesia via the EIDO tracker and are expecting underlying currency returns to boost performance as the Rupiah appreciates back towards its 20-year mean. Indeed, looking at a chart of the EIDO, one sees that Indonesian stocks in dollar terms are currently -30% below 2013 highs!

Singapore trades at an even more attractive multiple of 12.50x forward earnings. The nation’s stock market has not run-up with U.S. stocks, so we like the decorrelation potential going forward. We use the EWS tracker, which gives underlying exposure to Singapore Dollars. Singapore is one of the strongest nations in terms of trade balance and national debt, so we would not worry about exposure to SGD.

Malaysia is a bit more expensive at 16.63x forward earnings. We like diversifying into another Asian nation and especially the exposure to the Ringgit, as explained in the Currency section. We use the EWM to get exposure to both Malaysian stocks and the Ringgit.

The Philippines is in the same situation as Indonesia. The index trades at a bit more expensive ratio (17.58x), but we will stay long as the Philippines index, provided it does not make lower lows. Again, it in the underlying currency, the Philippines Peso, that is of interest to us. We use the EPHE tracker to get exposure to both Philippines stocks and the Peso. The EPHE (Philippines stocks in Dollar terms) is over -20% below 2013 highs, to give readers an idea of the magnitude of the currency return-to-the-mean trade.

While China’s Mainland stock market is looking ugly, we know that it’s a “no-brainer” to get invested in the world’s next economic Super Power at bargain prices. The A-share index (CSI 300) is only trading at 10.71x forward earnings. While we won’t jump in with both feet yet, we have a soft target around the 2014 lows. Perhaps the time to resolve the Trade War and we’ll get down to this rising trend line on the index. We use the ASHR to get exposure to Chinese A-share stocks.

We picked up Turkish shares during the crisis in Turkey last August. So far this has been a good trade for us. Turkish stocks (in dollar terms) remain at crisis levels, 25% off the panic lows of August. At 6.59x forward earnings, Turkey is probably the cheapest country worth owning at this time. The local currency index below came down sharply in 2018 but remains in its long-term up-trend. Indeed, Turkey is another currency play, as the Lira is still -30% below its 2018 high from January. We use the TUR tracker (which pays a nice dividend) to get exposure to Turkish stocks and the Lira.

VII. Final Thoughts For 2019

We believe that 2019 will be a year of transition. The Bull Market in the U.S. will likely continue to form a top below 2018 highs, the euphoria for Growth stocks will fade as Value regains importance as an investment criterion, and U.S. equity markets surrender relative out-performance to non-U.S. equity market.

The new year will also be challenging (or rather frustration) for those who have gotten too comfortable sitting in passive index fund products. A focus on downside protection will be required, including relying on a manager selecting the best companies, and not blindly following capitalization-weighted equity indexes lower in the name of “cost savings”. Our focus in 2019 will be on high-quality earnings (while not over-paying for  that quality), solid balance sheets, while avoiding firms who begin seeing EPS and revenue revisions revised down.

Active investors will need to start thinking like nimble day traders. Volatility is back. The roller-coaster gets bigger in 2019. Extreme volatility comparable to the Great Depression 1930’s where five times over ten years the broad market in the U.S. rallied about +100% before crashing. The reasons today might be attributed to the impact of mass media on market sentiment, to the use of inverse and leveraged ETFs, to computer algorithms, or even to the Fed and other central banks. But there will be important geo-political narratives to consider, like (i) the crude oil rebalancing programs of OPEC and Russia, (ii) explosive conflicts in the Middle East, (iii) BREXIT, and (iv) possible impeachment and removal from office of Trump and the end of his tariffs/trade wars. We may finally be in a time of socio-political and economic instability where Gold becomes a portfolio staple.

At WMA, our strategies will adhere to the thinking laid out in this Commentary. Our macro DGR Strategy will be focusing on non-U.S. equities with greater attention to downside protection. The DGR may opportunistically short U.S. indexes on rallies that peter out. We really like our Top Picks portfolio going into 2019. Top Picks will be avoiding U.S. index component stocks and focusing rather on value-oriented companies (notably in the Energy space) along with foreign companies with strong fundamentals. We update our fundamental scores weekly for Top Picks and run our trading models daily. Being attentive to both improving/deteriorating companies fundamentals as well as possible inflection points in stock price trends will be necessary in order to outperform in 2019. Finally, we remain patiently invested in the fundamentally strongest Energy companies and miners in our Natural Resources portfolio. The Bull Market peak in broad equity indexes appears to be coinciding with the Bear Market trough for the Energy sector.