2019 Outlook: Confidence Rots from the Head Down

2018 ended in a quarter marked by risk aversion, driven by loss of confidence at the very top – by the fright imparted by Trump’s deliberately aggressive and unpredictable approach to high-stakes brinksmanship with US/China trade and Iran. Markets have lost confidence in Powell as well, heightened by the ambiguities of Trump’s approach to managing him. The bear market in oil has put risk into credit markets, and that has grown into a generalized fear of leverage. The consequence is the highest US equity risk premium, and the lowest forward P/E multiple, since 2013. We predict the US/China trade war will be settled favorably in Q1, and that a deal has already been cut with Powell. OPEC cuts should at least put a floor under oil, which will alleviate some credit stresses. As fear clears in 2019, the “dot plots” may end up being right, with further Fed hikes fully justified by improving growth and inflation, higher long-term yields and a wider yield curve.