Morgan Stanley
  • Wealth Management
  • Nov 26, 2018

Markets Send Message of Caution

This is a time to listen to markets, which are signaling caution across multiple asset classes.

Lisa Shalett Wealth Management Head of Investment & Portfolio Strategies

When I analyze the markets each week, I usually focus on indicators like inflation, economic growth and corporate profits. Sometimes, however, the most powerful indicator of where markets are headed is the behavior of the markets themselves.

That is the case now. While the news is not all bad, the message is clear: Caution ahead. Below I list the behavior of six asset classes and what each of those markets is telling us:

Cash is the best-performing asset class this year. Cash, a catch-all term for money markets and very short-term bonds, is yielding near 2%, thanks to the Federal Reserve raising short-term rates. With several more rate hikes on the horizon, the return on cash is likely to move higher. Holding cash seems like a good risk/reward proposition now.

Corporate bonds are having a rough year. Investment grade credit has had its worst returns since 2008, despite growth this year in corporate cash flows and profits. That shows bond markets are pricing in more risk ahead.

Cryptocurrencies are reaching new lows. I mention the decline in this fledgling asset class since it can correlate with market sentiment. The new lows indicate that the risk-off mood remains firmly in place.

Large-cap stocks are more reasonably priced. The price-earnings ratio of S&P 500 has fallen to 15 from 18, which is a much more reasonable level. In 2019, I think companies that grow profits faster than expected should see positive returns. Most companies may struggle next year to meet estimates, however.

Bonds are correlating with stocks. Treasury prices are down this year, failing to counter falling stock prices. Typically, bond prices rally when stocks fall, creating a buffer for investors who have diversified. The fact that they haven’t this year may signal that we are in a secular bear market for bonds that may continue for awhile.

The dollar may have peaked. The dollar is up 5% this year compared with a basket of other major currencies, but my analysis suggests it may be about to roll over. This would be negative for U.S. assets versus the rest of the world, but could point to better times ahead for emerging markets and gold.

Bottom line: While market behavior makes me cautious, I see select opportunities ahead for patient investors. Stock valuations are reasonable, which means companies with strong earnings should outperform next year. For 2019, I suggest seeking out active portfolio managers who can identify opportunities in U.S. stocks. Meantime, consider using the remainder of the year for tax-loss harvesting and portfolio rebalancing to keep your asset allocation in line with your long-term goals.

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

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