Morgan Stanley
  • Wealth Management
  • Jan 14, 2019

2019 Investment Roundtable: Finding Value Amid Volatility

What could markets have in store for 2019? Members of Morgan Stanley’s Global Investment Committee discuss.

Each December, Morgan Stanley’s Global Investment Committee, a group of the firm’s most experienced  investment experts, gathers to collaborate on the  outlook for the new year. This outlook, which will be adjusted throughout the year, guides our advice to our Wealth Management clients.

This year, we hosted a webinar, giving each GIC member an opportunity to elaborate on the key points they want to emphasize in the new year. I offered a market overview and we heard from:

Read on for a text version where I ask them all some questions:

Wilson: Let’s start with the U.S. Outlook. It’s my view that we are still in a long-running secular bull market, but we’ve experienced a shorter-term cyclical bear market in 2018. It’s been a tough year with increased volatility, but the good news is that we think most of the price damage from the rolling bear market has been completed at this point. Where can investors find opportunity in 2019?

Andrew Slimmon: I think we need to look at the U.S. market in terms of growth stocks vs. value stocks. I expect the rotation from growth to value to continue in 2019. One reason is that momentum stocks (those that have done the best in the past year), have gotten very expensive in our opinion. Every time they’ve gotten this expensive, they have begun to underperform. The momentum bucket is mostly filled with growth stocks. About half of the companies in that bucket are from technology and consumer discretionary sectors. They are also owned widely by many funds and individuals. This crowding could lead to more downside for growth stocks. 

Wilson: Is this already happening?

Slimmon: Yes, momentum stocks have started to underperform, which we think is healthy. Value stocks are typically cheap, but they are cheaper now relative to their history. As long as we don’t have a recession, this looks like a good time to buy value stocks. In 2019, we expect earnings growth to slow, but we don’t forecast an economic recession. While value sectors have discounted the slowdown in growth, the growth areas have not. That’s why we think we will see a rotation from growth to value.

Wilson: Let’s talk now about the second major theme we see this year—the rotation from U.S. equities to international stocks. 

Andrew Sheets: The big change we see coming in global markets is that we think the U.S. will move from an outperformer to an underperformer compared with the rest of the world.  The issue is that U.S. economic growth is likely to slow more than expected next year, while China and Europe are likely to meet already low expectations. That could reverse a number of market dynamics—the U.S. dollar could weaken, U.S. yields could fall while European yields rise, and non-U.S. stocks should outperform U.S. equities.

Wilson: What about valuations?

Sheets: Valuations are a part of this story, but we think the key point is that it’s in U.S. stocks where the earnings deceleration will look most extreme. We expect outperformance from emerging market equities.

Wilson: Is the picture the same in fixed income? 

Sheets: It’s similar. We remain quite cautious on U.S. credit. We think it’s poorly positioned given this late-cycle environment of slower growth and tighter monetary policy. Plus, we think underlying balance-sheet quality is still relatively low. Instead, investors should consider emerging market fixed income. Valuations have improved and this asset class should benefit from a weaker dollar and lower U.S. rates.

Wilson: What do you think is next for credit markets?

Vishwanath Tirupattur: In U.S. credit markets, we’ve seen strong growth in the lowest-rated segment of investment grade, the BBB-rated credits. We think this segment has substantial downgrade potential and could be the stress point in the credit cycle going forward. If a lot of BBBs are downgraded, that would add a meaningful chunk to the high yield (below investment grade) market, which it would have to absorb. Plus, foreign investor inflows to credit markets have slowed considerably. While valuations are finally closer to fair value after the selloff over the last few weeks, for long-term investors, it is likely there is still more downside to come in corporate credit as we go into 2019.

Wilson: The government bond market might seem to be more of a “safe haven.” Are there risks there to be aware of?

Lisa Shalett: I recently wrote a special report on the implications of increasing U.S. government debt and deficits. This debt growth is a legacy of the low interest rate environment of the past decade, which led to companies and governments taking on much more debt. I worry about the implications of all this debt at a point when interest rates may be poised to rise even more. That means higher debt servicing costs at a time when the economy may start to slow. 

Wilson: What should investors do in response?

Shalett: I think cash is going to regain its status as a critical part of portfolios. Plus, the most attractive stocks will be ones with quality cash flows and an ability to pay growing dividends. I also think hedge funds and market-neutral strategies could make sense to add to the portfolios of some of our clients.

Wilson: Why hedge funds?

Rui De Figueiredo: Broadly, I think the current environment favors active management. That’s because volatility is higher and skilled managers, from stock pickers to hedge funds, can often use volatility to their advantage. Some hedge fund strategies may also offer downside support and consistency, which can be attractive in our more volatile investment landscape.

Wilson: What else can investors do to manage risk in their portfolios? 

Martin Leibowitz: I’d like to bring up an important finding from a study we recently completed on equity risk premiums, or the extra return above the bond yield that investors can expect to earn for taking on the risk of owning equities. We found that the longer you hold stocks, the more likely it is that you will be rewarded with this excess return. Or to put it more simply: Your investment horizon is a key factor determining how much risk you should take. It’s a good point for investors to remember at the conclusion of a year like 2018.  

Wilson: And a good point to remember going into 2019. Thank you all for joining in this discussion.

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