At our recent client event in Boston, Chief Investment Officer Leo Grohowski and Dan Clifton, Partner and Head of Policy Research at Strategas, gave investors a sense of what might be in store for the markets in 2019.

Q. What should investors expect in 2019?

LEO GROHOWSKI: In 2019, investors should expect more modest returns and continued volatility. However, the overall market environment will still provide a generally positive backdrop for equities thanks to solid corporate earnings. We expect S&P 500 companies to deliver a year-over-year earnings growth rate of about 5 to 10%. This should translate into an operating earnings range between $165 and $175. Earnings growth is what matters to markets, and that growth will continue, albeit at a slower pace.

But to put that slower pace in perspective, consider that the pace of earnings growth between 2017 and 2018 was extraordinary — 20% year over year. So while earnings are slowing, they're doing so after a robust year.

DAN CLIFTON: I'm bullish on the economy as a whole. Since 1946, stocks have declined right after the midterm elections on five occasions, but in each case they were up over the next nine months. In that same time span, the S&P 500 has never been down 12 months after the midterms.

Q. What role will policy play in the market in 2019?

LEO GROHOWSKI: With the Fed indicating a more patient approach and the shutdown resolved, monetary policy risks are more subdued for 2019. However, risks around trade can still play a role in investor sentiment. We will continue to monitor policy actions in the U.S. and abroad, as they can impact growth in the markets.

DAN CLIFTON: I think trade is the biggest policy issue weighing on the economy and markets currently. I believe that there's about a 70% chance that the trade conflict between the U.S. and China won't escalate any further. And I think President Trump will be inclined to resolve it soon, especially as the 2020 election campaign begins to pick up. The thing about presidents is: they like to get reelected. So they tend to avoid doing anything too crazy with the economy in the run up to their reelection campaign.

Q. What do you recommend for investors who want to get off the sidelines and back into the market but are concerned about volatility?

LEO GROHOWSKI: They may want to take a look at customized hedging solutions, which can shield against losses up to a certain point and, in many cases, offer a return greater than that of the benchmark index. So, for instance, our most recent S&P 500 Buffered Risk-Enhanced Return Solution (BRERS) offers an enhanced upside return two times that of the S&P 500 (though it's capped at 25.85%) and a downside buffer of 10%. This means that if the index generated a 15% return, the holder of a BRERS structured note would gain 25.85%. However, if the index returned -20%, the BRERS would only lose -10%. The note has a maturity of two years.

Q: Are we getting close to a recession?

LEO GROHOWSKI: I see little sign of a recession over the next 12 to 18 months. Earnings growth is still solid and consumers look fairly healthy. I would say there's a very low chance of a recession in 2019, perhaps 10 to 20%.

DAN CLIFTON: I don't think we'll see a recession this year. Last year, consumers drove the economy. I'm looking for a trade deal to help drive growth in 2019. Right now, the market is pricing in zero interest rate hikes in 2019. So I'm less concerned about a policy mistake derailing the economy.

Q. What are interest rates saying about the economy?

LEO GROHOWSKI: There's been a lot of attention paid to the shape of the Treasury yield curve, which has been flattening over the last few months. Historically, when it inverts, it's thought to indicate a coming economic recession.

The short end of the curve has moved lower because the market expects the Fed to remain on hold. The long end of the curve has declined due to low global sovereign rates and lower inflation expectations. It seems unlikely that the yield curve will fully invert, especially given where bond yields stand outside of the U.S. Even if it did, that doesn't mean a recession is right around the corner. It would more likely be several years away.

Q. What are the biggest risks to the market?

DAN CLIFTON: Even if the trade situation is resolved, there is still a lot going on in the world today that can shake up the markets: Brexit, Italy, the aftermath of the U.S. midterm elections and the threat of another government shutdown. The Economic Policy Uncertainty index hit its highest level ever in December 2018.1 However, this index tends to be a contrary indicator of the market.

LEO GROHOWSKI: In addition to these risks, we are watching inflation. While consumer prices have been generally contained near the Fed's target of 2%, wage inflation hit its highest level since 2005. While a 3.2% year-over-year rise in wages is still at a level that would keep the Fed on pause, we will continue to monitor the trajectory of wage pressures.

Q. What should investors be doing to navigate this market environment?

LEO GROHOWSKI: Take a more balanced and flexible approach. Rebalance if necessary. Incorporate diversifiers to buffer against volatility and hedge against the downside. But first and foremost, be active rather than inactive. I believe that will make a significant difference in the long run.

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