From Nuveen Investments

2019 Outlook

Be Active, Don’t Overreact

 
  • We expect improved equity market returns over the past year, but we anticipate volatility levels to remain elevated.
  • With the normalization of monetary policy, the beta driven market of the past five plus years should continue to transition to a market environment where focusing on company fundamentals and security selection adds value.
 
Year in Review

Following the highly anticipated Tax Cuts and Jobs Act, passed in December of 2017, strong upward earnings revisions supported positive equity markets during the first 9 months of 2018 while also decreasing valuation levels. By October however, the effects of the late-cycle fiscal stimulus were quickly replaced by a growing number of concerns, including uncertainty over future trade relations between the United States and China, the world’s two largest economies. This lack of clarity on trade, combined with rising interest rates, concerns regarding slower global growth, and the return of downward earnings estimate revisions, caused considerable uncertainty and a spike in market volatility that remained elevated throughout the fourth quarter. Despite lackluster returns and elevated market volatility, corporate earnings growth remained strong and will likely finish the year up over 20%. However, the sudden shift in market sentiment has stoked investor fears that the prolonged business cycle is coming to an end and a recession is imminent. We disagree with this notion.

We believe the fourth quarter of 2018 marked the “transition” to the later stages of the business cycle, not the end of it. While late stage business cycles have historically produced positive equity market returns, the source of the returns are often different than what drove performance early on. With the normalization of monetary policy, the beta driven market of the past five plus years should continue to transition to a market environment where focusing on company fundamentals and security selection adds value.

 
Be Active, Don’t Overreact

As we enter 2019, we expect improved equity market returns over the past year, but we anticipate volatility levels to remain elevated. Although financial conditions have begun to tighten and economic growth has decelerated modestly, leading indicators for consumer health and business activity have not fallen off a cliff as they typically do prior to a recessionary period. In fact, they appear far from it. Low unemployment and tight labor markets have resulted in an uptick in nominal wage growth while forward S&P 500 earnings growth estimates are just over 8% for the year.

Given our expectations for normalized volatility levels, combined with an increased market focus on company fundamentals and valuations, an active approach to equity allocation and security selection could prove beneficial. While we are aware of the risks that exist within the market, we have identified several themes we will be monitoring closely as we head into 2019.

  1. Companies with relative capital advantages should benefit in an environment of rising interest rates, widening credit spreads, and record levels of corporate debt. As the cost of capital goes up, company margins come under pressure which creates a competitive advantage for companies that are less reliant on debt capital to fund operations. We expect companies that exhibit free cash flow acceleration and high credit quality to be rewarded.
  2. Companies with a capital allocation policy that balances shareholder return with re-investment in future growth are ideal. Passage of the Tax Cuts & Jobs Act boosted earnings and left most companies with an influx of cash. Early uses of much of that cash went to share buyback programs and dividend increases leaving many worried about the lack of investment in future growth. The lack of clarity on future trade policy has likely created a temporary headwind for CAPEX but corporate capital allocation plans should come under more scrutiny as the market looks for future organic growth.
  3. With an increasing focus on company fundamentals, valuations are likely to matter much more than they have in recent years. Following several years of increasing equity market valuations, multiples contracted in 2018. We believe the valuation disparity between dividend-paying and non-dividend paying companies has reached extreme levels. The non-dividend paying segment of the S&P 500 is currently trading near its largest premium relative to the index, while the dividend paying segment is trading at a discount to the index.
 
Looking Ahead

At Santa Barbara Asset Management, we believe 2019 will be an ideal environment for an active approach to identify what we believe to be high-quality, dividend growth companies. Focused on fundamental analysis, we seek companies with sustainable payout ratios, future earnings growth, healthy balance sheets and strong management teams committed to dividend growth. In the later stages of an economic cycle we believe these companies provide an excellent way to participate in the equity markets in a meaningful way while remaining well positioned to help mitigate downside risk in the event of heightened volatility or a market sell off.

Risks and Other Important Considerations

This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy or sell securities, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor's objectives and circumstances and in consultation with his or her advisors.

This information should not be relied upon as investment advice, recommendations, offers or solicitation of any particular security, asset class, fund, strategy, or investment product. Investing entails risk, including the possible loss of principal. There can be no assurance that any investment or asset class will provide positive performance over any period of time. Dividend yield is one component of performance and should not be the only consideration for investment. Dividends are not guaranteed and will fluctuate. Equity investments such as large-cap stocks are subject to market risk or the risk of decline in response to adverse company news, industry developments, or a general economic decline. Investments in small- and mid-cap companies are subject to greater volatility. Non-U.S. investing presents additional risks such as the potential for adverse political, currency, economic, social or regulatory developments in a country including lack of liquidity, excessive taxation, and differing legal and accounting standards. Past performance does not guarantee future results.

The statements contained herein reflect the opinions of Santa Barbara Asset Management, LLC (“Santa Barbara”) as of the date written. Certain statements are forward looking and/or based on current expectations, projections, and information currently available to Santa Barbara. Such statements may or may not be accurate over the long-term. While we believe we have a reasonable basis for our comments and we have confidence in our opinions, actual results may differ from those we anticipate. We cannot assure future results and disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Statistical data was taken from sources which we deem to be reliable, but their accuracy cannot be guaranteed.

Santa Barbara Asset Management, LLC is a registered investment adviser and an affiliate of Nuveen, LLC.

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