2019 will likely be a stock picker's market.
Best ideas: We see attractive opportunities in high quality companies with attractive valuations and strong free cash flow. Our focus will be on identifying and selecting individual stocks based on fundamental research.
- While we remain positioned for a continued bull market, we are reducing exposure to select momentum growth stocks with frothy valuations. Bond proxy sectors appear expensive given their lower growth rates. However, we have been selectively buying high quality companies in traditionally defensive sectors such as health care and consumer staples, while evaluating hard hit sectors such as financials and energy.
- We believe we are in the late innings of the bull market, but the cycle is not over yet. We see market corrections as buying opportunities and continue to emphasize quality growth companies and cyclical sectors. If a recession comes earlier than expected, amid higher rates or inflation, investors would be less willing to pay premium multiples for growth. Market neutral, defensive, quality and yield strategies should become more compelling in such an environment.
- Recent market volatility was driven by concerns over the timing of the peak of the economic cycle, tariff rhetoric and unease over higher inflation and higher interest rates. Following the market’s recent downturn, valuations have contracted to attractive levels. However, we believe the markets will remain in a trading range until most headwinds subside.
- Given expected volatility and a heightened focus on valuations, we expect 2019 to be a stock picker’s market. Returns should mainly come from companies with strong fundamentals trading at reasonable valuations.
Taxable fixed income
Positioning for late-cycle trends.
Best ideas: We favor BBB rated bonds and the financial sector, as well as shorter-duration high yield corporates, bank loans and asset-backed securities. We also like preferred securities. Local emerging markets with attractive real rates, benign inflation trends and steeper yield curves offer opportunities.
- Treasury yields have risen since mid-year, with wider credit spreads leading to negative year-to-date returns in fixed income markets. We remain defensive, although we believe a near-term recession is unlikely and credit markets should remain stable into 2019.
- Credit spreads should be supported into the higher rate environment, as domestic growth has been pulled forward in the current cycle. Net supply in domestic investment grade and high yield bonds will likely trend lower in 2019, as the market adjusts to higher rates and merger and acquisition volumes subside.
- We favor investment grade credit, preferring higher quality BBB rated securities and financials over industrials. We are upgrading quality in high yield corporates. Senior loans remain attractive over the long term for their shorter duration, higher yield profiles.
- Within structured asset classes, we favor seasoned commercial mortgage-backed securities with more permanent capital support and shorter duration, high quality asset-backed securities. However, we remain underweight mortgage-backed securities based on relative value.
- Emerging markets continue to struggle due to persistent dollar strength and higher U.S. interest rates. Geopolitical risks centered on trade tensions, Brexit and a harder-than-anticipated landing in China may generate volatility. Notwithstanding those risks, we see opportunities in select higher yielding emerging sovereign and credit markets where current spreads more than compensate for the macro fundamental risks.
Expecting stronger returns in 2019.
Best ideas: We believe the steepness of the municipal yield curve will cause longer-term bonds to outperform over time. We expect high yield municipals to continue outperforming due to spread narrowing and better income cushion versus interest rates.
- Rising Treasury yields generally pressured municipal bond returns lower throughout 2018. However, municipals proved more resilient than other fixed income asset classes for several reasons: higher coupons with higher income distributions, improving credit quality, moderate new issue bond supply and the longer-term benefits of the 2017 tax reform legislation.
- New issue supply was down less than expected, although net new issue supply was negative due to municipalities calling and maturing more bonds than they issued. Refunding supply declined, partially due to the new tax laws. New money issuance somewhat offset the decline. Municipalities are more confident in their cash flows and are willing to borrow money to upgrade infrastructure to support economic and population growth.
- We continue to favor credit risk overall. The municipal revenue environment is strong, credit ratings upgrades exceed downgrades and defaults remain low. The Puerto Rico, tobacco, utility and land secured sectors saw the highest returns in 2018. While we believe Puerto Rico and tobacco returns should moderate in 2019, other sectors such as health care, transportation and education should lead more balanced sources of returns distributed more evenly across sectors.
- We expect Fed policy moderation and more stable and possibly lower inflation and commodity prices. As markets discount these shifts, U.S. Treasuries should stabilize in the first half of 2019, benefiting municipals.
Challenging markets require selectivity and proprietary access.
Best ideas: We favor structured or preferred equity solutions for high-growth middle market companies. “Green” credit products in renewable energy are in high demand from European investors.
- Private market conditions have become more challenging, with stiff competition for deals accompanied by rising interest rates and possible slower economic growth. Private equity demand remains strong as investors seek the sector’s diversification and absolute return advantages. Private debt continues to attract record fundraising on its history of predictable cash flows and low default rates. However, we believe rising multiples on equity deals, combined with demand-driven yield compression and weaker debt covenants, are forcing investors to become even more selective.
- Overall, smaller companies in the middle market appear attractive because investors can negotiate covenants and have more control over company management. Middle-market opportunities include private equity, direct equity co-investments, mezzanine debt and senior loans. Relationships with private equity general partners and access to their proprietary deal flow are important in helping investors to identify companies with better credit profiles. In a rising-rate environment, non-cyclical companies with strong cash flows are better able to cover higher debt service costs.
- Private debt is generally more attractive than equity in a maturing economic cycle, as it offers structural and collateral protection in the event of a default. Direct loans offer covenant protection, a senior position in the capital structure and can offer floating rates. In addition, selective infrastructure and energy project finance deals offer stable, long-term cash flows.
- Risks to the outlook include the potential for a global recession and rising interest rates, which put pressure on valuations and returns.
Benefits of global diversification in the late cycle.
Best ideas: We favor global agriculture’s defensive characteristics in the late cycle. Commodity trading strategies using proprietary algorithms may capitalize on pricing inefficiencies. Also attractive are industrial real estate related to e-commerce and real assets hybrid securities offering high income with relatively low interest-rate sensitivity.
- U.S. and global economic growth continue to support real assets, but valuations in certain markets and risks posed by rising interest rates and tariffs require investors to be highly selective. In private farmland and timberland markets, global diversification offers the potential for higher returns and could mitigate the effects of the strong dollar and tariffs. In public real assets, continued economic expansion favors growth-oriented sectors in the U.S. and developed markets that are less sensitive to rising interest rates.
- Low commodity prices for corn and oilseeds, a strong dollar and trade disputes continue to weigh on U.S. row-crop farmland returns, but may create buying opportunities. Attractive opportunities exist in U.S. permanent crops and non-U.S. row-crop markets. Tariffs have caused a divergence in soybean prices, for example, giving Brazilian farmers an export advantage over those in the U.S. Although quality opportunities exist across many farmland sectors and regions, their relative attractiveness tends to be deal-specific. Permanent crop development projects in Australia and South America offer counter-seasonal production, competitive cost structures, water diversification and free-trade agreements with key importers. In addition, agribusiness investments in clean, healthy protein continue to benefit from growing consumer demand.
- U.S. timberland performance has benefited from a sustained recovery in domestic demand and strong export demand in the Pacific Northwest and South. Although U.S. South performance overall has struggled, the outlook for returns is positive in specific sub-regional markets. Non-U.S. timberland continues to be an important component of any diversified timberland portfolio and can improve risk-return efficiency. Markets outside the U.S. may offer faster tree growth, access to strong forest product industries and lower costs of production. A shortage of native tropical hardwoods, such as teak and mahogany, has created opportunities for high-value investments in sustainable plantations in Central and South America.
- Public real assets markets late in the cycle favor companies with high and stable cash flows, strong balance sheets and the ability to self-fund growth. Real estate opportunities include global rental housing, e-commerce logistics and industrial facilities and student housing. Global infrastructure subsectors likely to benefit from continuing economic growth include technology, waste, commuter and freight rail, and toll roads.
- In commodity markets, trade disputes have depressed prices in industrial metals and agriculture, but potential easing of U.S–China tensions could lead to a rebound in 2019. Energy markets, which were volatile in late 2018, are likely to improve as supplies tighten. OPEC production cuts of up to or exceeding 1 million barrels per day are expected and U.S. production growth is expected to slow in the long term. Overall, commodity markets historically have improved in rising-rate environments and late-stage economic expansions.
- Risks to the outlook include a stronger U.S. dollar, continuing trade tariffs, inventory growth across commodities and a more rapid transition to slower growth and recession.
Commercial real estate
Structural change creates opportunities in the late cycle.
Best ideas: We favor investing in 90 global cities offering scale, growth, sustainability and resilience. Attractive sectors include global real estate debt, global industrial and apartment, student housing in Europe and manufactured housing in the U.S.
- Real estate fundamentals are expected to remain solid in 2019, despite the market’s late cycle, rising interest rates and structural change disrupting the office and retail sectors. Positive global growth forecasts and an overall balance of supply and demand continue to support net operating income and property values. Commercial real estate continues to attract capital, with stable income returns generally exceeding those available in fixed income. However, little or no capital appreciation can be expected and putting new capital to work remains challenging.
- Structural change driven by demographics, technology and consumer trends are creating opportunities to add alpha. We expect global cities benefiting from advanced technology, sustainable development and rising urbanization to outperform through changing market cycles. The upheavals impacting office and retail are generating demand for high-tech buildings with flexible office space and light industrial warehouses. We believe some of the best opportunities exist in alternative sectors, such as data centers and manufactured housing.
- Residential apartments globally are benefiting from strong demand among middle-income families and millennials priced out of home ownership. Global real estate debt’s stable income returns and lower volatility have offered risk protection for real estate equity portfolios.
- Risks to the outlook include underestimating the need to “future-proof” portfolios by incorporating exposure to emerging new sectors, such as providers of flexible office space and co-living apartment buildings.
Data Source: FactSet and Bloomberg for market and economic data
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The Bloomberg Barclays Municipal Bond Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds. The Bloomberg Barclays High Yield Corporate Bond Index is an unmanaged index considered representative of non-investment-grade bonds. The MSCI ACWI (All Country World Index) is a free float-adjusted market-capitalization-weighted index that is designed to measure the equity market performance of developed and emerging markets. The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Nuveen’s Third Annual Responsible Investing Survey: Nuveen commissioned Harris Poll and was conducted online from June 1 - 27, 2017 among 1,012 affluent investors. (U.S. residents over age 21 with $100,000 in investable assets (excluding workplace defined contribution accounts or real estate), who consider themselves the decision maker for financial decisions and who currently work with a financial advisor). A covenant is a promise in an indenture, or any other formal debt agreement, that certain activities will or will not be carried out. Algorithmic trading refers to automated trading by computers which are programmed to take certain actions in response to varying market data. Alpha is a measure of performance on a risk-adjusted basis. Middle market refers to medium-sized businesses (neither small nor large).
A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Foreign investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria excludes securities of certain issuers for non-financial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not suitable for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
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