• 4Q18’s volatility was disproportionately large relative to the strength in US fundamentals.
  • Profits growth will likely slow in 2019, but growth rates should remain positive. We do not see a profits recession until 2020 or later.
  • Liquidity is starting to be withdrawn from the global economy, but this is a normal late-cycle development.
  • The stock market reflects behavior in the real economy. Investors and, more importantly, corporations have been very skittish. Those fears have limited irrational behavior throughout the cycle.
  • Stock market volatility, therefore, does not appear to be primarily attributable to traditional fundamental variables. Rather, a highly capricious political environment is making corporate and household planning nearly impossible.
  • Investors must keep their wits, ignore short-term noise, and invest based on longer-term fundamentals.
  • 2018 ended with an emotional “run” on the equity market during which fear played a larger role than did fundamentals. 2019 is likely to be more fundamentally based and our portfolios are positioned for the opportunities we see, but investors should be wary of powerful late-cycle rallies that might occur despite slowing or deteriorating fundamentals.

    Our portfolios are currently structured with a bias toward China, stable growth, and short-term Treasuries.

    China is the only major economy attempting to stimulate

    China’s stock market was one of the worst performers during 2018. The combination of a trade war and slowing global growth was not a good one for such an export dependent economy. However, the weakness in external demand for Chinese goods led the government to stimulate the domestic economy with significant monetary and fiscal programs. In fact, China is the only major economy that is attempting to incrementally stimulate their economy.

    One of the reasons we were so bullish on the US economy earlier in the decade was our belief that monetary and fiscal stimulus would work. Many pundits suggested the US economy would have an “L” shaped recovery, meaning that the economy would basically never recover from the “Great Recession”, and that the business cycle was effectively dead. The US economy did, of course, recover and there was a significant bull market.

    There are similarly negative statements made today regarding the future of the Chinese economy, and how their monetary and fiscal efforts will prove impotent.

    Chart 1 shows that there may be hope for the Chinese economy because of those stimulative measures. The chart compares the OECD Leading Economic Indicator for China versus that of the US, and the two indicators have been moving in opposite directions. Whereas the US indicator (green line) is increasingly suggesting an economic slowdown, the Chinese indicator (blue line) is beginning to improve. The China Leading Indicator’s recent improvement is quite unique. Chart 2 highlights that China is one of only two major economies with improving leading economic indicators (Australia is the other).

    Admittedly, Chinese corporate profits have yet to improve, but evidence is starting to build that they might accelerate in 2019. China is our primary overweight outside the US.

    CHART 1:
    China vs. US: OECD Leading Indicators


    Source: Richard Bernstein Advisors LLC, OECD, Bloomberg Finance L.P.

    CHART 2:

    LEI Momentum
    Based on 1/14/19 OECD
    Release


    Source: Richard Bernstein Advisors LLC, OECD