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.

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.