QMA expects global growth conditions to deteriorate further in the near term, but bottom later this year. Despite this, QMA still sees low odds of a recession. The risk of a policy mistake from overzealous tightening looking forward has greatly diminished since the Fed put its hawkish stance on hold in January and emphasized patience on interest rate policy and increased flexibility on reducing the size of its balance sheet. At the March meeting, the Fed went further, ruling out additional rate hikes in 2019 and announcing that the balance sheet runoff will slow in May and end in September. There are early signs that a more dovish monetary policy is starting to work through the system from China to Europe to the U.S., manifesting itself in an easing of financial conditions and the potential for a trough in global growth. Indeed, 12-month forward earnings expectations for emerging markets and the U.S. are showing signs of bottoming and are likely to improve in the second half of 2019.
Three reasons QMA expects recession odds to remain low
Headwinds turn to tailwinds
Slowing global growth, Fed hawkishness, continued trade tension between the U.S. and China, and a U.S. government shutdown led to sharp market declines in the fourth quarter. However, markets rebounded sharply in the first quarter as developed market central banks turned dovish, China continued to provide stimulus, and trade tensions eased.
Investors expecting rate cut in the U.S.
With the Federal Reserve putting rate hikes on hold, the fed funds futures curve is suggesting a high probability of a rate cut by year-end.
Benign inflation allows central banks to focus on growth
China continues to increase monetary and fiscal stimulus, while the European Central Bank (ECB) recently launched a third round of targeted longer-term refinancing operations (TLTROs). With inflation in the developed economies remaining low, central banks in these markets can afford to pause on policy normalization and focus instead on stabilizing growth.
Positioning for a risk-on environment
Given the relatively healthy backdrop and dissipation of recession fears, QMA added some risk into its portfolios in the first quarter. Its top equity allocation remains the U.S. market. While markets may need some time to consolidate or pull back after such a robust start of the year, QMA thinks stocks should remain in an uptrend near term, driven by dovish central banks and reasonably attractive equity valuations. It has also become positive on emerging markets, which could benefit from dovish central bank policies, a stable dollar, lower oil prices, a resolution of the trade disputes, and an eventual rebound of the Chinese economy. In fixed income, QMA has also added risk modestly, shifting to higher yielding assets such as U.S. high yield bonds and emerging market hard currency debt.
An update on U.S. small-cap equities
With recession fears easing, a shift to a friendly Fed, and a more positive investor sentiment, QMA believes that market conditions for small caps have improved. Valuations are still supportive, even after a year-to date melt-up, and small caps still trade at a discount to large caps on a forward earnings basis. Earnings growth for small caps is expected to be robust over the next 12 months, at 15% compared to 6% for large caps—an attractive value proposition.1 The current macroeconomic backdrop is favorable for small caps, even though we are in the late stages of the business cycle.
Read full QMA 2Q 2019 Outlook and Review , which is available for financial professionals.
1 Source: FactSet, FTSE Russell as of 2/28/18.
The views expressed herein are those of QMA at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. This commentary does not purport to provide any legal, tax, or accounting advice. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Each manager has no obligation to update any or all such information, nor do we make any express or implied warranties or representations as to the completeness or accuracy.
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1021058-00001-00 Ed: 5/2019