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By Brent Puff - October 31, 2018
A year ago, I talked about the favorable backdrop for equity markets driven by synchronized economic growth around the world and the strength in corporate profits. Today, the economic backdrop is more disjointed, equity markets are more volatile and the two largest and most important economies on earth—the U.S. and China—are in the midst of a growing trade war.
Although we acknowledge equity returns face a few more challenges going forward than they did a year ago, we continue to believe the outlook for equities is favorable and here’s why: the rate of growth in corporate profits is still fairly strong and economic activity, while moderating, remains healthy.
The headwinds our investment team continues to closely monitor include US dollar strength, inflation, the continued tightening of US monetary policy, and economic disruption induced by US/China trade friction.
In my latest quarterly video, we’ll do a deep dive into all of these issues and also reveal what single issue surprised me the most in the third quarter.
On balance, we continue to believe that equity returns will remain positive going forward given the combination of moderate economic activity around the world and continued strength in corporate profits. I think, with that said, we believe the pace of returns in the market is likely to moderate from recent trend, given our belief that corporate profit trends in 2019 are going to decelerate.
We are already seeing a slowdown in growth in several large geographic regions of the world today. China and the eurozone are probably the two most notable areas of slowdown, and we believe trends in the U.S., both in terms of economic activity and corporate profit growth, will slow heading into 2019.
There are several headwinds that will restrain growth next year, specifically, number one, the strength in the U.S. dollar. And number two, continued pressure on cost. And number three, disruptions from the escalation in trade between the United States and China. All three of those items will serve to diminish the pace of growth in corporate profits and be somewhat of a headwind for equity returns going forward.
The additional constraint on equity returns, in our opinion, will be the U.S. Central Bank, which appears likely to continue to raising rates. That will work against valuations looking into next year.
I think one of the things that surprised me in the third quarter was really the degree to which the trade tensions with China appear to be escalating. As we sit back and observe sort of the relationship between the United States and China, one of the things that I think is clearer today, than maybe it was three months ago or six months ago, is that the Trump administration really believes that on balance their perspective on trade is more right than wrong, and they are willing to sort of get into a more protracted skirmish with China—even if it means slower near-term growth because they believe in the long run. It's best for the country, and I think that perspective is a little clearer today than it was three to six months ago.
It's very difficult to say with any degree of specificity when the trade dispute with China will be resolved. It appears to us as though escalation is the more likely path, at least over the near term. With that said, we believe that cooler heads will ultimately prevail, but tariffs and the threat of more tariffs is likely to weigh on growth trends next year, unless we reach resolution. We just don't know when that's going to happen.
I think the choppiness in the market is going to continue. The political backdrop around the world continues to be unsettled. I'm not sure I see that resolving anytime soon. Economic activity around the world continues to be a little more bifurcated than it was a year ago. I don't really see that changing. We're still growing, but the very favorable backdrop we were in a year ago has moderated. There's more disparity in trend around the world and, again, I think that's going to continue.
So I think, going into the fourth quarter heading into 2019, a lot of these uncertainties that continue to gyrate across the market are unlikely to be resolved.
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Despite a disjointed and volatile economic backdrop, Portfolio Manager Brent Puff remains optimistic on the 2019 outlook for equities. One issue, however, did surprise him in the third quarter of 2018.
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Economic activity around the world is softening, which Sr. Portfolio Manager Brent Puff believes could make finding future growth more challenging.
Despite the first quarter market rally, Global & Non-U.S. Equity Portfolio Manager Brent Puff notes slowing global growth.
Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.