Bank of America Merrill Lynch has forecasted the "bear market vibe" to continue into the first half of 2019 as it makes its top ten macro predictions for the coming year, but added it expects to turn "tactically risk-on" in late spring.
The bank's research team predicts modest gains across both equities and fixed income in the coming year, but cautioned the squeeze on liquidity from higher rates and a flattening yield curve would create further market volatility.
However, the analysts have called for investors to make volatility "their new best friend" in the coming year as they also forecast a record high peak in earnings for the S&P 500, saying the US market still has the potential to provide plenty of upside.
Candace Browning, head of global research at BofAML, said: "In our view, the current weakness in the markets is not a reflection of poor fundamentals.
"Rather, it is caused by a confluence of idiosyncratic shocks that create very real risks for investors to be concerned about but also opportunities for vigilant, well-positioned investors to pursue."
Based on this view, BofAML's global research team has made ten key macro predictions for next year:
1) Global profit growth declines
Earnings growth is expected to decline sharply next year, from >15% to < 5% on a year-over-year basis. The BofAML research team is bearish on stocks, bonds, and the US dollar; bullish on cash and commodities; and long on volatility.
The analysts expect to turn tactically risk-on in late spring, but to start 2019 with a bearish asset allocation of 50% in stocks, 25% in bonds and 25% in cash.
2) S&P 500 index peaks
The team is also forecasting a slowing in earnings growth in the US, although it sees a positive near-term outlook.
They expect the S&P 500 index to peak at or slightly above 3,000 before settling in at a year-end target of 2,900. It is also forecasting earnings per share (EPS) growth of 5%, which would put the S&P 500 EPS at a record high of $170 next year.
The bank's US equity strategists are overweight healthcare, technology, utilities, financials and industrials, and underweight consumer discretionary, communication services and real estate.
3) Cash gets competitive
With cash yields higher than dividend yields for 60% of the S&P 500 already, the analysts see cash becoming even more competitive in 2019.
They are forecasting Fed short rates to reach close to 3.5% by the end of 2019, well above the S&P 500's 1.9% dividend yield.
The analysts also points out that in a rising-rate environment, cash-generative investments have outperformed credit-sensitive assets.
"Given cash's re-rating, 2019 boils down to a strategy of buying sources of cash and selling users of cash," they said.
4) US economy slows as fiscal stimulus fades
Real GDP growth in the US is expected to sit at 2.7% in 2019, slowing in the second half of the year as the effects of fiscal stimulus begin to fade.
Meanwhile, the unemployment rate could reach a 65-year low of 3.2% by the end of the year, leading to wage growth of 3.5% in aggregate.
As a result, core price inflation in the US is expected to rise gradually to 2.2% over the course of the year, along with interest rates.
The analysts said: "The housing market is no longer a tailwind for the US economy: we believe housing sales have peaked and home price appreciation is forecast to slow."
5) Global economic growth decelerates
However, the global economy is forecast to grow 3.6% in 2019, down slightly from 3.8% in 2018, with inflation hovering around 3%.
Most major economies are likely to see decelerating activity, with real GDP growth of 1.4% in both Europe and Japan, and 4.6% growth in aggregate among the emerging markets.
BofAML also says Chinese growth is likely to further weaken early next year as a result of financial conditions remaining tight and the continued US-China trade conflict. At the same time, however, it expects to see a "steady stream of monetary and fiscal stimulus measures to turn the economy around".
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