As we closed out 2018, a fair amount of our time was spent looking into 2019; discussing the themes that we thought would drive markets. This discussion helped narrow down a list of what we felt commanded focus. Each of the themes has multiple facets and, in some cases, many possible outcomes. Over the next couple of months, we will be expanding on these key themes in greater detail. We welcome your feedback and thoughts.
2019 promises to be another volatile year in the markets. We believe the fixed income markets will experience similar ups and downs as we experienced in 2018, however, with much greater uncertainty and the potential for more severe outcomes. With the greater uncertainty will come significant dispersion and differentiation, especially in the credit markets. Active management that focuses on resiliency and the ability to adapt to the volatility will be required. Our concerns around passive management are more amplified after the moves we saw in 2018. Additionally, many managers with generic over-weights in credit felt significant pain in 2018 and were dealt a friendly reminder of the importance of security selection and security avoidance – both crucial components of active management. We are definitively moving into a bond picker’s market.
The core of our thesis around heightened volatility in 2019 rests on the view that we are coming off a period of money being priced below its natural rate. The artificial rate environment created capital market distortions and, in many places, poor investment of capital in the economy. The mispricing of money also resulted in behaviors and actions by individuals that created some unhealthy imbalances in the markets. We believe we will continue to contend with these imbalances and the re-pricing of risk throughout 2019.
The intended and unintended consequences of the great monetary experiment (QE) are still widely felt in the economy and markets—some positive and some very negative. We believe that as money is repriced to a natural/neutral rate, the residual outcome is (and will be) a significant repricing of the excesses created by the cheap money. Some of these show up in our themes for 2019.
Many of us were raised with the mantra to ‘not fight the Fed’. We believe this is a healthy reminder and one that should be heeded again. Central Banks around the globe are scrambling to reverse the great monetary policy experiment to prepare for the next rescue. The importance of reversing course is increased by the recent tension in global relationships. The Fed has raised rates nine times while starting the reduction of its balance sheet. Other Central Banks are following suit. With these ongoing changes will come heightened volatility and uncertainty but, most importantly, new valuations and repricing of risk.