WWRR Vol.2.017

THE INVESTMENT OUTLOOK FOR 2019: LATE-CYCLE RISKS AND OPPORTUNITIES
Civilian unemployment rate and year-over-year wage
growth for private production and non-supervisory workers
EXHIBIT 1: SEASONALLY ADJUSTED, PERCENT
14%
12%
10%
8%
6%
4%
2%
0%
May 1975: 9.0%
Nov. 1982: 10.8%
Jun. 1992: 7.8%
50-year avg.
• Unemployment rate
• Wage growth
Jun. 2003: 6.3%
Oct. 2009: 10.0%
6.2%
4.1%
Oct. 2018:
3.7%
Oct. 2018: 3.2%
’70 ’75 ’80 ’85 ’90 ’95 ’00 ’05 ’10 ’15 ’18
Source: BLS, FactSet, J.P. Morgan Asset Management.
Guide to the Markets – U.S. Data are as of October 31, 2018.
As unemployment continues to fall, wage growth may rise
somewhat further, as it did in October, as shown in Exhibit 1.
However, the lack of responsiveness of wages to falling
unemployment this far in the expansion speaks to a lack of
bargaining power on the part of workers that should persist
into 2019, holding overall wage inflation in check.
Finally, consumer inflation should remain relatively stable in
2019. A mild acceleration in wage growth will, undoubtedly,
put some upward pressure on consumer prices. However, a
recent rise in the U.S. dollar and fall in global oil prices should
both work to keep inflation in check. Higher tariffs might, of
course, add to consumer inflation in the short run. However,
their depressing effect on economic activity would likely
counteract this. With or without higher tariffs, we expect
consumer inflation, as measured by the personal consumption
deflator, to end 2019 in much the same way as 2018, very close
to the Fed’s 2.0% long-run target.
With regards to the U.S. dollar, the currency may face some
further upward pressure early in 2019 as U.S. growth remains
strong and uncertainty around trade abounds. However, later
into the year, the combination of a slowing U.S. economy, a
more cautious Fed and tightening by international central
banks should cause the U.S. dollar to end 2019 flat to down
compared to the end of 2018.
FIXED INCOME: TIME FOR THE BUBBLE PACK
U.S. fixed income investors have faced a tough environment in
2018. Faster growth, growing fiscal deficits and balance sheet
reduction pushed the U.S. 10-year yield from 2.40% at the end
of 2017 to 3.15% by mid-November. The Bloomberg Barclays
U.S. Aggregate has fallen 2.3% year-to-date, looking set to end
2018 in negative territory – only the fourth year since 1980
that the benchmark has registered an annual decline. So what
might 2019 hold for investors in bonds?
The Fed should continue to raise rates early in 2019, adding
two more rate hikes by mid-summer and pushing the federal
funds rate to a range of 2.75%-3.00%. However, if economic
growth slows in the second half of 2019, inflation should
remain remarkably stable for this late in the cycle. This could
allow the Fed to pause its hiking cycle at that point, and
economic data may not give them reason to resume
tightening again.
A number of other central banks will also join the Fed in
gradually tightening monetary policy in 2019. The European
Central Bank will finish purchasing assets by January 2019 and
should begin raising rates by mid-2019. Other central banks,
such as the Bank of England and the Bank of Japan, should
engage in some form of modest tightening.
Some investors may see this global tightening as a concerning
development since, in many ways, central banks have provided
the training wheels to help stabilize markets over the course of
this cycle. However, the gradual removal of these training
wheels shows that central banks believe economies can now
cycle on without their support – a sign of strength, not of
weakness. Nevertheless, while the removal of this support
should be viewed as a positive, it could trigger increased
volatility and gradually rising yields.
So how should investors be positioned going into next year?
As we get later into this economic cycle, it is important that
investors begin to bubble pack their portfolios. This, in effect,
means dialing back on some of the riskier bond sectors and
seeking the safety of traditional fixed income asset classes.
This step may involve sacrificing some upside in the short term
for additional protection.
J.P. MORGAN ASSET MANAGEMENT 3