MASTERCLASS: Outcome-Driven Solutions
April 18, 2019
Laura Keller: 2018 started out just great for companies and the investors that put money into them with the U.S. Corporate Tax Rate slashed to twenty percent. But these last few months of 2018 have been bogged down by worries on trade, rates, the economy that's led to anemic returns. The total return for Morningstar's Broad Market U.S. Stock Index this year through mid December was barely positive, a gain of less than half a percent. Very few of the bond indexes that Morningstar also tracks have made a positive total return this year.
Laura Keller: So investors and their advisors want to know what's in store for next year, what should they expect, and where should they be putting their money for 2019. We're putting those questions to our panel today, a panel of experts with expertise in bonds, in stocks, and economics. So let's welcome to our Outlook 2019 Masterclass Megan Greene, Global Chief Economist, John Hancock Asset Management, Jacob Weinstein, Senior Analyst, Asset Allocation Research at Fidelity, Francis Gannon, Co-Chief Investment Officer at the Royce Funds, and Owen Fitzpatrick, Managing Director and Lead Portfolio Manager, Aristotle Atlantic Partners.
Laura Keller: So thank you all for coming in to our studios. Let's get right to it, shall we? Let's start, if we can, just characterizing what we've seen in 2018 and where investors ... what they've had as far as their experience. Megan?
Megan Greene: Yeah, sure. So from a global economic standpoint, coming into 2018 we were all inundated with outlooks for 2018 saying that we were going to enjoy this global synchronized growth because that's what we saw at the end of the previous year. And that didn't really pan out actually, the U.S. ended up pulling ahead largely down to fiscal stimulus measures in the tax bill and the spending bill. So the U.S. ended up growing well above it's potential GDP growth rate, but other economies actually have seen their growth kind of converge with potential GDP growth.
Megan Greene: So we saw a pretty sharp slow down in Europe. There's been a really sharp slow down in China starting actually at the end of last year. There's been a slow down in Japan as well. So this global synchronized growth story didn't really pan out and we've also seen a lot of volatility in the markets off the back of that. In 2017, there wasn't a lot of volatility and we finally saw that return which of course provides opportunities, as well as pitfalls, for investors.
Megan Greene: But there are a few things that we have continued to see in 2018 and that's kind of a low rate, low growth, low inflation environment. Now the U.S. was well above the potential GDP growth rate, but the system was kind of goosed by fiscal stimulus measures. So if you're looking at fundamental potential GDP growth, it hardly budged. Inflation's finally hit the Fed's targets, but hasn't really hit most other central bank's targets. And so it's remained stubbornly low and rates have finally started coming up, in the U.S. at least, but of course the ECB and the Bank of Japan are stuck with bottom, low rates. And the ECB might change that next year, but the Bank of Japan's stuck in there for a long time.
Megan Greene: And the Fed, while in a rate hiking cycle, is having to go really slowly. So that's very much a theme that we've seen since the global financial crisis is low rates, low inflation, low growth. We've seen a bit of an acceleration in the U.S., but not really anywhere else and I think that really sets the scene for 2019, what can we expect. And I think probably a synchronized global growth story, but on the downside now, not on the upside. So everybody kind of converging with their potential GDP growth rates.
Laura Keller: Right. So 'goosed' I think is the term that Megan coined here, what do you guys think? What have you seen for 2018? What have investors experienced?
Jacob Weinstein: Yeah, so when we came into the air from Asset Allocation perspective, our view was after extremely nice period of global synchronized growth in 2017 ... very low volatility, markets just going up and up and up, and then positive optimism from those tax cuts that you mentioned earlier ... Our view was actually with the Federal Reserve started to normalize policy, with the European Central Bank starting to back off, the Bank of Japan thinking about doing less accommodation, I mean think about 2017. There was two trillion dollars in [inaudible 00:04:14] added to the overall markets from central banks. And that was expected to not necessarily go negative last year, but be less than two trillion.
Jacob Weinstein: And so our view was we'd have more volatility and there was a couple of episodes of ten percent corrections, which made sense. Our view was that with a maturing economy in the U.S. that you'd probably see less rosy growth backdrop despite those positive news that you saw and optimism coming out of Washington.
Jacob Weinstein: So now you look at 2018, a great year for earnings, twenty four percent I think it was for corporate earnings. Can you actually eclipse that and get near that for 2019? It's gonna be a little bit harder hurdle to reach.
Laura Keller: Certainly so.
Francis Gannon: So from a small cap perspective I can really dive down into a specific area of the market which is where we tend to concentrate. It's been a year of two halves, if you will, up until the market peaked at the end of August of 2018 and then kind of to current.
Francis Gannon: The market was very squirrelly going into the peak of the market, which is a technical term [crosstalk 00:05:14]
Laura Keller: Is it?
Francis Gannon:... that we should use often, but it was marked by growth doing extremely well in particular non earning companies within the Russell 2000. About thirty six percent of the Russell 2000 is comprised of non earning companies, one of the highest numbers we've seen at a non-recessionary period, but those non earning companies were up close to twenty three percent to the market peak at the end of August of this year. While companies that actually had earnings were only up twelve percent, which is kind of an oddity in the market and hence the technical term 'squirrelly'.
Francis Gannon: I think from that moment on where we've had at least a seventeen percent correction through the middle of December here, things have kind of reversed. You've seen valuations come more into play, earnings come more into play, dividend paying companies come more into play, risk has come back to the overall market. So the corrective phase we have seen begin in the second half of this year, I actually think is quite healthy. And the question is where will it end or if it will end, and how does that fit into 2019?
Laura Keller: And hopefully we'll get into that coming up. Oh and how 'bout yourself?
Owen Fitzpatrick: I call it the 'Year of Reversals', right? We ended up with the end of September with the dollar strong, oil doing quite well, growth investors within the equity market outperforming value, the U.S. moving along based on it's own fundamentals at a pretty good clip, and the rest of the world correcting. And now all of a sudden rather than the rest of the world catching up to the U.S., the U.S. has caught up to the rest of the world, value has significantly outperformed growth, oil prices have declined quite a bit, and the dollar has weakened. So it was a sharp reversal and I think the two main issues out there are Fed policy and the comments that Powell made back just two months ago, and then obviously the trade issues that we're facing with China are the two big ones that caused that reversal.
Laura Keller: Right. Well let me actually add one more to your list there of those three and maybe I can add in political instability, I guess I'd say. So if we take, let's say, those three on the table there. What do you guys think? Which one are we most concerned about heading into 2019, if we had to pick just one?
Laura Keller: Go ahead. Anybody, go ahead.
Megan Greene: I'd say if you had to pick just one, it would probably be the Fed. So ten out of the past thirteen rate hiking cycles have landed in recession. So the Fed really has forum on killing off recoveries. Now economic conditions in each of those cycles were totally different, so it's not totally far to blame the Fed, but I do think as we're looking at an incredibly flat yield curve, yield curve inversions usually assign post to recession.
Megan Greene: There are questions about how much the Fed can really get, in terms of rate hikes. I also think our growth has been well above potential GDP growth and inflation's finally hitting the Fed's targets, but looking into next year ... Home sales and home prices have been pretty soft and I think we can expect that to continue with higher rates and shortage supplies, tax code changes. And so if home prices are soft next year, that's one of the biggest weights in the inflation basket. And then we might get some kind of drug repricing next year as well, in which case medical costs will also be soft, that's another one of the biggest weights.
Megan Greene: And so inflation, I'm not calling for disinflation in 2019, but we probably can expect it to accelerate significantly, which is good news because it means we're not going to see the late cycle surge in inflation that we usually get so late in the business cycle and that means the Fed can take their time.
Megan Greene: So you referred earlier to J. Powell's comments a few weeks ago saying that we're close to the range of neutral rates. That was just a factual statement, but he was also walking back a market overreaction, I think, to previous comments of his. And I think his analogy that their approach to monetary policy is like you're in a room full of furniture and you turn out the lights, and all of a sudden you have to go really slowly and carefully. And that's how they're approaching monetary policy and normalization is a really good analogy and I do think that is how they're approaching it.
Megan Greene: So the Fed remains the biggest risk, but they're aware of their record in terms of killing off recoveries and I think that they are going to continue to go gradually. There's no real impetus for them to accelerate any time soon. So I think that's the good news.
Laura Keller: Yeah, they do seem to be aware, as you say, of that. Frank, you had some comments on that.
Francis Gannon: Yeah, I agree. I think the Fed is one of the things we're going to have to watch next year, perhaps more than tariffs and tweets, and the inflationary issue is the question of the day. I think if things are on hold for the moment, after the December tightening, then the question is what do they do going forward and how do they go?
Francis Gannon: The comments we hear from management teams, and being a small cap firm we spend a lot of our time meeting with management teams, so I feel we get kind of real time economic data bottoms up. Inflation is a topic for discussion. Commodity pricing is going up. Labor is going up. So there are certain components of the inflationary picture that I think are worth watching and how that is going to affect the Fed next year is, I think, going to be important.
Laura Keller: So both Megan and Frank both think the Fed. Are you in agreement, Jake and Owen?
Jacob Weinstein: I'll take a different side of that. I'll take trade on this one.
Laura Keller: Okay.
Jacob Weinstein: Not that I don't think what the Federal Reserve does is extremely important, I pay attention very closely to what they do, but to Megan's point, the reason why it may not be the most important thing is because inflation is low. They have the wiggle room to not necessarily go as fast as they would think they would need to go in order to cool down these inflationary pressures.
Jacob Weinstein: So wage growth while accelerating, hasn't really reached those levels that's high enough for them to feel the need to put a full throttle stop on an overheating economy. Now you look at trade and why that's so important, it may be a little bit above more important than the Federal Reserve, is because it doesn't just impact the economics, but it also impacts business confidence.
Jacob Weinstein: I've talked to a lot of business owners, they can't really make any decisions of what to do if they're not certain on what those policies are gonna be in terms of trade. So it's very [inaudible 00:10:56] confidence is very much so, but also what trade does is it exacerbates these late cycle types of pressures. Because we think about late cycle, what it means to us is inflationary or hits profit margins. So if tariffs start getting implemented at higher rates and you start getting these escalated situations, then some companies ... they'll be able to pass those prices along to their end consumers and that causes inflation and maybe the Federal Reserve will have to respond and raise rates at a faster pace. Or some companies, who won't be able to pass it along, actually have to take a lower margin and decrease in margins is also definitive of late cycle.
Jacob Weinstein: So I think this trade issue is something that might, could potentially accelerate the overall economic cycle.
Laura Keller: Okay. And Owen, you didn't get to weigh in on that, on what you brought up to begin with, so go ahead.
Owen Fitzpatrick: Sure. I agree. I think it's really rates to a large extent. It has much bigger impact on the economy just given that you're repricing debt at much higher levels. I also think when you look at kind of what the Fed's dealing with is unprecedented territory, right? We're dealing not only with raising interest rates, but shrinking a balance sheet. And then doing that in a global economy where developed markets really are still on the start line, right? The gun went off, we're halfway around the track raising interest rates, and we look back and everyone's still at the start line and sitting at zero, and you have that additional pressure of the dollar.
Owen Fitzpatrick: And then the last thing I'd highlight is that you're also dealing with, versus past cycles, very high sovereign debt levels. So we're sitting here with twenty one trillion in the U.S. We can reverse back to what happened in '08 and '09 and I think the biggest influence in markets at that point in time were really sovereign debt issues. So if we start to head back to higher interest rates, it's a little bit of a difficult territory for us because the fastest growing component of our annual spending in the U.S. is actually interest expense.
Owen Fitzpatrick: So it becomes a harder and harder story to tell and we all know where it ends, right? We can look at Japan and see what happens when you spend as much money. They're a little encapsulated from the standpoint that they own their own debt, we have a little bit more of an issue in trying to convince people to take on our debt.
Owen Fitzpatrick: So I think that's why interest rates are really the story here. I think tariffs are very important and I think it will have a big impact, but I think interest rates really take precedent.
Laura Keller: Right. Well, I mean that's a lot on the plate I think for 2019. So let's get into what you think about 2019, as we look ahead into the year. So start us off. And tell me also if you're looking at back half stuff of next year or if you're looking to front load some of the conversation. So Owen, we'll start with you on this one.
Owen Fitzpatrick: So I do think we get a bounce back. The market reaction was pretty severe in relation to how quickly it reversed from a pretty nice upward trend, and I think the fundamentals are still there for the market to do well. I think the Fed will, at some point in time, back off of these rate hikes in 2019. So I think a lot of people are starting to suggest that we're not going to see three rate hikes in 2019, maybe it's two, maybe it's one, and then maybe it's a pause. And I think that pause is definitely going to be the case.
Owen Fitzpatrick: So I think it's going to be positive for asset classes in the U.S. in general and I think the earnings backdrop is still going to be positive. Not the twenty four percent growth that Jake eluded to, but probably high single digit type of earnings growth which is more than supportive to push the equity market higher and then valuation levels are reasonable rates.
Owen Fitzpatrick: And then the last component of it is just the fact that I don't think we really can afford higher interest rates, so I think at some point in time you do have to back off and you do have to try to get growth going. That's not only in our interest, but that's really a global issue in developed markets.
Laura Keller: And when you say 'we' though, do you mean consumers, companies, who do you mean exactly can't afford that?
Owen Fitzpatrick: I don't think the economy really can because of the issue around the size of the debt problem, the sovereign debt problem. We went from a technology bubble to a real estate bubble to a sovereign debt bubble. It's not easy to convince people to sell their technology stocks to put more margin in their account. Foreclosing on a house is difficult to do. But convincing politicians to take a hard measure towards trying to reduce both entitlement programs and raise taxes, which is the answer, we know it's the answer, and eventually we'll get there, but there's no one near term that's gonna run on that policy.
Megan Greene: Yeah, can I ... So I agree, we have a sovereign debt problem. I'm just not convinced that it's going to become a huge problem for the U.S., at least for a long time, because we've got the global reserve currency and the biggest, most liquid asset class in the world. So we have a little bit more room to run, which doesn't mean that we shouldn't worry about it, just in the short term [inaudible 00:15:18].
Megan Greene: But we do have another debt bubble, I think, which is a non financial corporate debt. We've been on an absolute debt issuing bonanza for the past two years in the U.S. And if you look at corporate debt to GDP, we're at or above the levels that we were at for the past three recessions, so that's really alarming. If you look at corporate debt to profits though, we're well below historical highs, so that tells a totally different picture. And I think the answer to your point that rates are most important, that as long as rates are low and profits are really high, it's not an issue. But if rates are only going one way up and profits are probably going to start growing more slowly, at least for firms, then I think that could become an issue. And that's the only real systemic issue that I see in the U.S. that suggests that we could have a recession that's more than just a technical kind of two quarters of contraction recession.
Megan Greene: So I do think that might be a worry going into next year. I also think the fiscal stimulus measures that goosed our growth this year are set to peter out at the end of next year. And so the biggest hit from the fiscal stimulus was really in the first three quarters of this year, but I think by the second half of next year they'll mostly have worked their way through the system.
Megan Greene: And so by the end of 2019, we're really looking at a fiscal cliff. So there is a question about what that means for growth and I think economists have generally found a consensus that we're gonna have a recession in 2020. And I'd also say that when economists find a consensus on this, it will almost certainly not happen that year. But I think 2020's an election year, the government will be highly incentivized to provide more fiscal stimulus, so there could be room for this recovery to grow. But the slowing of fiscal stimulus, it won't be a drag on growth next year, but it won't be such a tailwind as it was this year.
Laura Keller: And I think when we talked earlier, you'd mentioned about the consensus around 2020 and you think maybe we have, like you said, a bit more room to run that perhaps that recession, if it happens, would be a little later.
Megan Greene: Yeah, it could be a bit later. As an economist, looking at the economy, there are very few signs of overheating actually. So sentiment is really high, but when it comes to actual capital deployment firms and individuals aren't deploying capital according to what they're saying they're feeling about the economy. So that's good news because that means this could last a bit longer. We're not overheating, the Fed doesn't have to play catch up and kill off this recovery. But I do think there are risks in the markets, I don't think they're in the economy, but in the markets. Corporate earning is falling pretty significantly, or slowing down at least, corporate earning's growth is slowing down and also things like non financial corporate debt.
Laura Keller: Of course. And Frank had mentioned the non earners, that whole picture.
Francis Gannon: Exactly.
Laura Keller: What's your outlook then on that front?
Francis Gannon: I'm in the camp that we continue to become and enter into what is a more normal environment, and we can all debate what normal might be, but to me it is an environment of higher rates where access to capital is not as easy as it has been over the past decade where effectively we've had free capital, you could argue.
Francis Gannon: I think you're going to see increased volatility, which to me is a good thing, it's very healthy. I think people were lulled to sleep by the lack of volatility in the market over the past several years and you're starting to see that in the latter part of the year here. And I also think you're going to see lower returns, which is something I don't think people have really thought about. They're used to seeing great returns, concentrated in certain sectors, and names within the market, but I do think overall you're going to see lower returns, which is also a good thing.
Francis Gannon: I totally agree with you about leverage. I think financial leverage is something we have to watch. Within the Russell 2000, you can argue that twenty percent of the index is actually compromised of zombie like businesses. These are businesses that actually have to borrow money to pay their interest on their current debt, which is frightening when you think about it.
Francis Gannon: So I think it's going to become increasingly important for people to be more thoughtful about how they invest. I think it's gonna be an environment where active managers tend to do better because of that. And to me, it's a good backdrop. It's a really interesting one, but there's gonna be increased volatility which long term investors are going to be able to take advantage of.
Laura Keller: And Frank your colleague was here a few weeks ago with us, Charlie Dreyfus, talking about these zombie companies and really thinking about the financial leverage picture. Of course if earnings do go down, but the data stays the same, obviously that's quite a bad ratio.
Francis Gannon: The Russell 2000, if you add up all the debt in the Russell 2000 at the end of the third quarter this year, fifty percent of that debt is floating rate debt. I mean that's frightening when you think about it in the environment we're living in right now. And I just don't think people are thinking about it in the right way.
Laura Keller: Right. Jake, your turn. Tell us more about your outlook.
Jacob Weinstein: Yeah. So our outlook for 2019, we take a very strong view on where we are in the business cycle and what that business cycle is. I mean whether you look at the U.S. or globally, it is pretty clear that global business cycles are maturing. There's very few economies out there that are in the early or even mid stage of their cycles, most are in the latter stages. And we even see China has entered a growth recession at the fourth quarter this year and is expected to continue to have some issues going into 2019. Because frankly the Chinese policy makers are having a lot of challenges given the debt issues you were talking about. They have significant build up of debt over the last ten years.
Jacob Weinstein: And so I don't expect of any type of massive re-acceleration out of the Chinese economy. And if we think about why China is so important, and we've talked about the Fed and trade a little bit, but China is so important because it really is the growth engine for the rest of the world outside the U.S. And we really need to get some sort of re-acceleration to see something out of China that's incrementally positive, we just don't see it quite happening yet. Now will things get worse in China? It's hard to say, but we don't see things getting any better any time soon.
Jacob Weinstein: So our outlook therefore, what we see is as these economies are later in the cycle, and when we think we've just got a little bit of taste of volatility in 2018 and these headwinds are likely to continue, and you're going to see the markets twisting around, bouncing around, pretty aggressively much more so next year than we've believed the last several years.
Jacob Weinstein: And so you've got several different headwinds and we've mentioned them. We've got the Fed, uncertainty there. We've got trade wars. We've got policy, to the fiscal point, that that's going to be rolling off in terms of tax cuts and monetary policy. And so ... And put it all in perspective, it's just much harder to overcome these risks that have built up more so. It doesn't mean we have to enter recession, in fact recession probabilities are very low. Unemployment rates are low, corporations still have nice positive earnings, things look good from an overall level perspective, but what matters with economic trends and business cycles is the rate of change and it's gonna be very difficult to accelerate from here.
Jacob Weinstein: So what we see is it either sideways or decelerating growth. Still positive, but decelerating. And that just speaks to Frank's point, suggests that returns are going to be much more harder to achieve.
Laura Keller: Right. Okay, well what about this? Can we say then, is it true, that we feel that there's ... the bull market is going to die in 2019? And if we agree there, 'cause I think we do, is it going to be a bear market where you see drawback of twenty percent or more if I can put it into that category? Thoughts?
Francis Gannon: From a small cap perspective, you could argue you're almost there from a bear market perspective. I mean, so another three percent would not be that surprising given where we are here in the middle of December. We went back and we looked at every corrective phase in the market since 1997, in the Russell 2000, of which there have been twenty two. The median decline is fourteen percent. The ones that are above twenty percent are typically twenty five plus, those are the ones that are clearly around the financial crisis recession. Those are pretty deep.
Francis Gannon: So we're almost there, from a small cap perspective, so that wouldn't surprise me. I just think it leads to that conversation again about lower returns going forward, but it would be the beginning of a new cycle.
Laura Keller: But are investors going to be ready for that? Having to reset those expectations that they maybe won't make much return next year?
Megan Greene: I think those expectations have already started to shift, actually.
Jacob Weinstein: Yeah.
Megan Greene: And I would say from an economics perspective, the economy looks really strong. I mean we're expecting two and a half percent growth next year, that's well above our potential GDP growth rate. So for all the pessimism actually, the economy looks pretty solid. And so maybe there's been a bit of an over adjustment on some of these things. So pricing and Fed hikes for next year, I think the markets way over shot and are too pessimistic now. I think the Fed can get two rate hikes. And so that can shift as that gets priced in over the course of next year, that could bring some optimism into the markets as well.
Laura Keller: Yeah, so it sounds like one area maybe where we can expect some kind of uptick there. 'Cause I think most of the things we're thinking for 2019 so far are maybe not so great. Owen, tell me if I'm wrong.
Owen Fitzpatrick: I would highlight we're dealing with lower energy prices, right? So that's significant in relation to both the consumer and businesses from an input cost perspective. So I think 2019's a little easier than 2018 from that regard. And then in addition to that, anyone that deals within foreign countries, the stronger dollar this year, especially beginning of the year, really did hamper growth. So I think those two things would be tailwinds in 2019. And then if we do start to see the Fed back off, I think that's a pretty significant event and we get any type of trade resolution, I think we could be dealing with a much more positive market. I don't see kind of the downside, just given the fact we're at very low unemployment rates. I know we all talk about the inverted yield curve that we're getting there, that we have that situation on the short end of the yield curve, but if you look at the ISM manufacturing number which is another great predictor of recessions, we're nowhere near seeing that dip below fifty.
Owen Fitzpatrick: So I really don't envision ... I think it's gonna be more of the emerging markets, international markets catching up and doing much better, just given how much they corrected in 2018 and having a much better 2019 than the U.S. kind of continuing to decline going into 2019.
Laura Keller: Sure.
Megan Greene: I think you make a great point on the U.S. dollar. So if the U.S. dollar does remain weak because the Fed's gonna go slower than most people had been thinking, that takes a lot of pressure off of emerging markets; however, if you think trade's going to get worse before it gets worse, and that the tensions will re-escalate and the PBOC responds by stepping away from the Renminbi and seeing it depreciate, then that would push the dollar up higher.
Megan Greene: So it's a really hard call, what's going to happen with the U.S. dollar, but it's absolutely crucial for emerging markets I think.
Laura Keller: Well, you brought up the inverted yield curve too. We haven't talked about that, so what are our thoughts there? Do we think ... I mean as Megan earlier pointed out, I mean we typically look at that spread between, the moves between the two and the ten. If it inverts there then, probably a recession coming.
Megan Greene: Yeah.
Laura Keller: Are we paying attention to only that? Do we think that that's something that will happen? We got pretty close recently. So just tell me if that's there because I think that's something that people ... people want to sink their teeth into one specific thing to look at because it's hard to parse through if the economy's doing well, but yet the stock market isn't. I think people have a hard time feeling a great understanding of why that might be.
Jacob Weinstein: Right. So the yield curve, obviously very important. It has successfully proceeded, successfully but proceeded, seven recessions in a row. I mean, it should not be ignored. Interestingly, the Federal Reserve the last two times it inverted tried to say, "Hey, this time is different." 1999 there's not enough bonds, we have a fiscal surplus, therefore our long terms rates are lower than they should be. Let's ignore this and keep hiking rates.
Laura Keller: Do they have an argument there this time? Do you think this is different?
Jacob Weinstein: You shall see in wait. I've seen some ... There's actually a Fed paper that does reference, elude to, this time is different. It looks very similar to the excerpts from 2005, 2006 global savings glut of why that time was different. And so those discussions go on the Fed, but think about what the Fed thinks about most, it's the rate of unemployment gains, it's inflation, it's CPI, core CPI, PCE, economic indicators. They pay attention to equity markets and spread markets, credit spread markets. They don't want to have financial instability, but they have an economic playbook where they follow the data and they are data dependent. And if they start to see the twos, tens invert, but if they tend to see inflation pressure still there, they will continue to likely hike rates.
Jacob Weinstein: Now will it be aggressive and try to stop it in an aggressive manner? Likely not. But it's very important to understand that they do tend to invert ... continue hiking rates after curves have inverted historically. And so the point there is, one, should you be concerned? Yes, but it does take some time for this to work into the overall recession area period. So when twos, tens invert and you think you get a recession any time between twelve and almost twenty four months when they invert historically, so it's not like it inverts and then you should sell all your equities 'cause you see a recession definitely coming. You can definitely have positive equity returns after curve inversions.
Laura Keller: So we shouldn't be as worried? Is that what we're thinking?
Megan Greene: Well.
Laura Keller: Go ahead, Megan.
Megan Greene: For what it's worth, I spend a lot of time talking to Fed officials and they do nothing but talk about the yield curve. So they are totally obsessed [crosstalk 00:27:50]
Laura Keller: So they're paying attention to it.
Megan Greene: They don't want to invert the yield curve, whatever J. Powell, and before him Janet Yellen, had said. You know, 'this time is different.' They spend a lot of time talking about it, trying to figure out whether it's going to invert or not. And there is this academic debate raging about whether yield curve inversion means that we're going into recession. The yield curve has a better predicted outcome than any economist I know, including myself, on recessions. But I think wherever you come out on that debate, whether this time is different or not, if investors all think that a recession's coming when the yield curve inverts, then when the yield curve inverts they'll behave accordingly, and we'll make it a self-fulfilling prophecy. So I do think we need to pay attention to it as a signal.
Francis Gannon: I have to say I'm not a fixed income person and I understand the importance of the yield curve and all of that, but I do think we've lived in an environment where people have been looking for the next recession now for a long period of time. And at the moment, what we're hearing again bottom's up, from companies domestically and even internationally, but domestically we're hearing that they are very cautiously optimistic about their prospects. Not in all businesses, but they are cautiously optimistic about their businesses.
Francis Gannon: The demand is strong at the moment and yes there are things to worry about, trade being one of them, but I just at the moment would say that I think underlying fundamentals are okay. Yes, the economy might slow next year, but that's okay. And with the market down as much it is at the moment, I think a lot of that is priced in. And there used to be a thing called the rolling recession, which people used to talk about how different sectors would go through these periods of time when they were out of favor. And you could argue that we're starting to see that domestically in the United States.
Francis Gannon: We've had oil, as you mentioned, come down so much dramatically this year. Several years ago you had many of the retailers go through this out of phase. So you have these industries that have been out of favor and so there have been pockets of slow downs, dramatic slow downs across the country, but I think a lot of it has already been priced into the market at the moment.
Laura Keller: Right. And well this is the time of year when, I think obviously, everyone is getting together their outlook for 2019. So as you review both yours and other peoples, are you seeing anything that you really strongly disagree with? Maybe it's not just one particular outlook, but maybe you're seeing something, Owen, where the market you think in general is sort of thinking about this incorrectly, the thought leadership that's out there is wrong on something. So I want to posit that to you because I think our audience would like to know if there is something that you disagree with that's out there, some kind of thing coming in on the horizon. Anything from you, Owen, on that front?
Owen Fitzpatrick: I think consensus is lining up. I mean, I think this correction to Frank's point has been pretty severe when you look at the size and the move. And even within industries, right, utilities are by far the strongest performing sector in the last three months and you have other sectors that are down over ten percent over the last three months, quite a few of them. So I think consensus is probably right on target this time.
Owen Fitzpatrick: I think one caveat I'd put out there is you don't know with Europe, it's just a hot bed of unrest. I mean you see what's going on in France, we know what's going on in Italy, what's going on in England. So I think that's an area where, from a political perspective, we could see further issues arise. Unforeseen issues frankly, just given where they're headed politically with the issues that they're facing, the differences from country to country in terms of what they really want to see from a monetary policy standpoint.
Owen Fitzpatrick: It's pretty easy here in the U.S. Think how complicated it is over there if you're sitting there and you're Italy and you want to head in a very different direction than Germany. And even look at the difference since the recovery, right? Germany's done extremely well from an unemployment perspective. Italy has gone in the opposite direction since 2008. So how do you really mesh that together and come to some type of conclusion?
Owen Fitzpatrick: So the area though I would highlight is one that probably will be more of an issue and probably add to the volatility that I think everyone on the panel's been highlighting, is really Europe.
Laura Keller: Mm-hmm (affirmative).
Megan Greene: Yeah, I'd agree with that. So I'm both a U.S. and a UK citizen, so I voted in the Brexit referendum and the U.S. Election that year, it was not my best year admittedly.
Laura Keller: Which we won't ask you about, but go ahead.
Megan Greene: Yeah. But in any case I think for the most part from where I'm sitting in Boston, most people really don't care about Brexit 'cause it will be terrible for the UK if there's no deal. But are there real implications for the U.S. economy? Probably not. For Asian economies? Probably not. For Europe maybe though, given supply chain disruptions and financial volatility.
Megan Greene: But I think you're right, that the markets are underpricing the risk in Italy. I mean this government has maybe, it's showing that maybe they'll step down in terms of their budget, a little bit though, we haven't seen any of the math behind that. So and this government's never had to put together the math behind measures and what that means for the budget before. So it's not clear that it works out.
Megan Greene: But this government has shown that they are much more confrontational with Brussels than any previous government. And also both parties in the government are deeply anti-European. So they've come off of their line. At one point they were both saying, "Yeah, maybe we should leave the euro." They've backed off of that, but that's not to say they won't get there again. I mean the day after the Italian elections, Salvini who is the head of League, the biggest party in Italy, said, "The euro always was, remains, and will be a mistake." That doesn't really instill confidence, so I do think that would be such an existential threat to the European project. I think the markets are probably underpricing that risk.
Laura Keller: Right. Any others that you guys think they are getting wrong?
Jacob Weinstein: Yeah. There's a few things I think the market might be misinterpreting. The fourth quarter they clearly are pricing in a recession and given what we're saying, I mean the U.S. economy is still strong, recession probability is very low. The market's a little bit bearish on that, so I think that'd be a positive inflection potentially and why you could get a nice perhaps run in the short run at some point.
Jacob Weinstein: But at the same time if you look at the Fed, again bringing it back to the Federal Reserve and maybe I do kind of agree with you as the Federal Reserve is the most important thing [crosstalk 00:33:31]
Laura Keller: Yeah, I was about to say, I'm not sure that you said that earlier.
Jacob Weinstein: Still important [crosstalk 00:33:35]
Laura Keller: Changing minds on the panel.
Jacob Weinstein: Yes, exactly, exactly. Never too late to change minds. You hear some good thinkers you want to just keep going on with it.
Laura Keller: Right.
Jacob Weinstein: No, but I think the way I think a lot of people think about it as market practitioners, we've been in this business for, some of us, several decades, and we think back to the times when the Federal Reserve cut rates were paused and when the markets responded positively. Federal Reserve said, "You know what 1987, that was pretty bad. We're going to come in and cut." And that helped fuel a nice run over the next year.
Jacob Weinstein: 1998, long term capital management, they came and cut rates a couple times. Markets had a several good year run after that. 2016 the Federal Reserve paused after issues China was having, we had several good years after that. I think people think that every time the Federal Reserve reverses course, pauses, and potentially cuts rates, it's a good time. But think about the times when they cut rates deeper in a cycle. A lot of times those don't actually have positive outcomes.
Jacob Weinstein: So I think there's good optimism potentially to be had if the Federal Reserve does slow down, but we should think about, "Well why are they cutting rates" if they do. Well it's because something bad is happening in the data and it could be telling us something that the market might not be ready to potentially hear.
Jacob Weinstein: So I'm a little bit both sides of that story.
Laura Keller: Anything from you, Frank, on that point? Or you think the market's got it pretty well handled?
Francis Gannon: I look at the Russell in our world. The average stock in the Russell 2000 is down thirty four percent from it's fifty two [inaudible 00:34:58]. There's a lot priced in at those levels. There's a lot of opportunity at those levels. I think we have been wrong to be ... if this was a confessional. We have predicted that value would come back stronger than it has. While it has come back of late, in the latter part of the year, growth has done extremely well for a long period of time and we were perhaps too early in calling the switch the value.
Francis Gannon: I still believe value is going to be an interesting part of the market going forward, just as fundamentals become increasingly more important. Not that they haven't been in the past, I just think the market was focusing on things ... When you look at the non earning area within small caps, they were in a zero interest rate policy world you could value these 'growth' companies ten, twenty years down the road. You can't do that anymore in a normal rate environment or a normalizing rate environment.
Francis Gannon: And so I think that's part of the rotation you should be seeing, obviously it hasn't happened as of yet. So I think that's gonna be a big component next year.
Laura Keller: Yeah. And fundamentals really looking at individual companies, seems like if you have the volatility that you do and the potential for more volatility, that you would want as an investor to really be very picky about which companies it is that you put your money in at this juncture.
Laura Keller: But let's move on here a little bit. Let's talk a little bit about some specifics within the market. We haven't gotten the chance to talk about sectors yet. So obviously on outlooks, people like to have some take away of something that you think would be ... I don't want to say hot pick because I tend to not think that's the greatest way to think about it. But going into 2019, what should someone come into at the beginning of the year let's say, and would remain valuable for them at the end of the year? Any sectors that you like particularly?
Owen Fitzpatrick: I would say I think we're going to get a nice bounce back in the ones that have corrected the most. So if you look at industrials, energy, I think those will be the ones to some extent that do rebound. They're also two of the cheaper sectors. They're trading quite a bit below where their market multiple is.
Owen Fitzpatrick: And I think from a defensive standpoint, healthcare continues to perform. It's up over ten percent, it's the strongest performing sector year to date in the S&N 500 and it has all the attributes you want. It's not overly expensive. It really beats to it's own drum in relation to the fact that you're dealing with, in many cases, with product stories. And product stories, doesn't matter what's happening in China from a trade perspective if you're developing a new cancer drug. It doesn't really matter in relation to where interest rates are headed. It's whether or not that drug works that's going to ultimately drive your stock price.
Owen Fitzpatrick: So I think product stories relative to secular growth, relative to cyclical growth take precedent in the type of environment that we're potentially heading into.
Laura Keller: Right.
Jacob Weinstein: Yeah. And if you put a business cycle lens again on the sector leadership, what you tend to get as you get later into a cycle are those more defensive and inflation sensitive type of sectors. So historically, energy. Materials tend to do better in late cycle. Every late cycle is different, so it's very hard to make assessments for 2019. I don't want to put my name right down on those, but that is historically what tends to do well.
Jacob Weinstein: In other defensive sectors like healthcare, staples, utilities do have more of a higher hit rate later in cycles than say earlier in the cycle compared to others of the cyclical sectors.
Laura Keller: Okay.
Francis Gannon: I'm gonna kind of have fun with you on this one. I agree. I think economical sensitive and cyclical areas of the market are very attractive right now. And we can debate where we are on the cycle. One of the more interesting things when you look at how this small cap cycle has been, is that the economic growth scares we've had, of which we've had several if you go back since the 2008 financial crisis, it was the more economically sensitive or cyclical areas of the market that got hit the hardest. And believe it or not, the more defensive areas have done really well.
Francis Gannon: And weirdly enough within the small cap area, healthcare is a great example. Ninety one percent of the biotechnology companies in the small cap space have no earnings. Eighty eight percent of the pharmaceutical companies have no earnings. So it's a different animal, I think, in our world. But to me the growth scares have created great opportunities and I think we're kind of having one right now based upon our ... are we in a recession, going into a recession debate here in the United States, that these economically sensitive and cyclical businesses ... which the better small cap companies are global in nature. They drive more of their revenue outside of the United States than people think.
Francis Gannon: I think that's where your opportunity lies going forward.
Laura Keller: Okay. Well we won't spend all day on sectors. We don't do that, but I do want to talk a little bit about trade wars. Obviously we've woven that into the conversation, but are you only paying attention to China or are you also looking at the new NAFTA for example? Is there something in Canada? Is there something in Mexico that you're also paying attention to, that I think perhaps anything you would think that our investor audience would also want to pay attention to?
Megan Greene: Well working for a firm that's headquartered in Toronto, we're obviously looking quite a lot at what I like to call "Esmukkah", rhymes with Chrismukkah, but the new NAFTA agreement. So it's not a slam dunk that it will pass Congress. The President has now threatened to withdraw unilaterally in order to try to galvanize Congress into backing it. So a lot of what we're looking at is, what are the chances that it will even be passed?
Megan Greene: If the President does try to withdraw the U.S. unilaterally, there will be a bunch of legal cases because it's not clear. The legislation around that isn't clear that the President can actually do that. Congress had to pass it to join it, so how can the President unilaterally withdraw us? That's the legislation pretty wholly on that.
Megan Greene: So that will not only affect the relationship between the U.S. and Mexico and Canada, but it will also take up a lot of oxygen in the room for other more useful policy to maybe be agreed on. So that I think could be a distraction.
Megan Greene: Well we have this détente with China though, I do think you're right to ask if there are other fronts on this trade war and in addition to Esmukkah, we also have the U.S. Administration also constantly threatening to impost car tariffs on the EU and Japan. So we might see some of that during this détente as well. It would be economically like shooting yourself in the foot for us to go ahead and impose car tariffs, but that doesn't mean that we won't do it.
Laura Keller: Right.
Megan Greene: I think we saw what happens to Germany's economy when the car sector has a huge headwind. We saw that with it's last GDP print, it went into contraction. And so that could be a huge drag on growth in Europe's real grown engine in a year when the [inaudible 00:41:11] is no longer buying assets. Italy's probably going to kick up a bit, and so it's a bit of a perfect storm for Europe.
Megan Greene: I know the Germans and the German car lobby are incredibly worried about this. And also Japan, we could end up imposing tariffs there too. So I do think the U.S. has opened up a multi-front trade war. The biggest and most contentious one was of course with China and there I think tariffs are a bit of a side show. It's really about who's gonna be the biggest economy drive by excellence and machine learning, quantum computing, artificial intelligence, and neither side has really any incentive to back off from their position on that. We both want to be the world leading economy.
Megan Greene: And so, and the détente that we reached at the G20 meetings does nothing to address any of that. So I think that we've got a bit of a pause, but this will probably get worse before it gets worse.
Laura Keller: Worse and worse is what you're saying.
Megan Greene: Yeah.
Laura Keller: But what about that. I mean so are we looking at this from a Donald Trump perspective, where the administration is really almost taking our trade partners one by one and trying to move things? Is that how we're looking at it? Or are you guys thinking something different from Megan and just focused on the China one?
Jacob Weinstein: Yeah. Well, I don't think it's so much about Trump right now going forward, regarding China, because if you think about NAFTA and China ... So NAFTA's a situation where we look at the base, of Trump's base, you look at most Americans in terms of poll and NAFTA is actually pretty popular, and most people wanted an agreement to come thought.
Jacob Weinstein: And so we saw a deal. Now, will we continue to get a deal? I don't know. It's very different to determine what these policy makers are ultimately going to do whether it's from the executive or Congress, but that is why I think we saw a deal.
Jacob Weinstein: Now why we haven't seen a deal with China yet? Could we get one? Possibly, but it's so much more complicated based on things that Megan was saying. With them accused of, and probably very likely, stealing our intellectual property over the decades, stealing our technology, it makes it very contentious. Not only just for the governments, but it's politically popular to bash China both in the Democratic and Republican side.
Jacob Weinstein: And so this situation is not just about Trump, this is a multi-year situation that we're going to probably, likely endure as U.S. and China strive to continue to fight to be the number one economic power in the world.
Jacob Weinstein: And so I think that China is extremely important. The likelihood of us singing a round of 'Kumbaya' with China and just holding hands and saying, "We're going to make a deal" is very low. Now will we see some sort of deal? Well perhaps, they buy soybeans from us for some concessions.
Laura Keller: Soybeans is something we seem to be paying very close attention to.
Jacob Weinstein: It's just soybeans though. So there's a lot of other things that are on the table, a lot of other issues that are not going to likely be resolved and they'll continue with us for the next several years. So a deal, could we get one? Yes, that might help markets be very happy over the next couple days, weeks. But ultimately will that solve all of our issues and will they all go away? Fairly unlikely.
Laura Keller: Mm-hmm (affirmative). How about the small cap space there, Frank? Is that something that's insulated from these trade wars whether it's Canada or Japan?
Francis Gannon: I wish I could say 'yes', but the answer's no and I think Jake actually made the point earlier about trade. The uncertainty is getting into the psyche of the management teams. They don't know quite yet how to approach it. They're thinking about it, trying to figure out what is the best approach. I haven't heard any instances by which they are talking about ... I've heard discussions about potentially moving plants outside of China or certain countries, but I don't think anybody's actually done anything per se as of yet.
Francis Gannon: It is also about the supply chain. It's about where they're getting their components that they need and that's going to become increasingly more important. So while we don't have an answer in terms of what's going to happen from a trade perspective, it is definitely affecting the psyche of the management teams. Even though everybody thinks small cap companies are domestically focused, which most are, but it is affecting them.
Laura Keller: Right. Owen, anything that we're missing in this debate? I mean, is there something that you're paying attention to very, very closely, or are there some other things that we should have in mind?
Owen Fitzpatrick: No, absolutely. I think it boils down to, I think, to Jake's point about intellectual property theft and the benefit that China's had from that. Building out industries that are pretty significant when you look at what they're going to do in semiconductors, what they're going to do in healthcare. And then the flip side of that, to what Frank brought up around companies coming out in the large cap space they are talking about sourcing elsewhere and China losing out from that standpoint.
Laura Keller: Moving to other Asian countries for example.
Owen Fitzpatrick: Or moving back in, a very small percentage moving back to the U.S., but most moving elsewhere to low cost areas throughout Asia. So I think that is a real risk for China. So China's got to make the decision. I've been doing this for over thirty years, we get to have a company move from the emerging markets to developed markets. And it's silly when we're talking about China being in the emerging market index when it's as large as it is, but there's certain boxes you have to check in order to make that move. And I think the ones ... Or you have to abide by certain rules. And some of the rules are, "You don't steal intellectual property. You don't force companies to open up and co-own plants in your country."
Laura Keller: Right.
Owen Fitzpatrick: So there are certain things that I think they ... They're at the point now, frankly, I would be surprised if they don't just start to cave because I think the benefit of caving is a lot greater in keeping all and sourcing a lot of that stuff within China. Building plants in China versus what they lose. So they've already stolen enough I think of intellectual property. We did it way back when we were in the [inaudible 00:46:36] country from many different areas in Europe. They're doing it today, but I think it's at the point now where it makes sense for them to put the gown on, and walk down the aisle, and receive the diploma, and head into the developed world.
Laura Keller: Right. And investors would be more confident to work with them if they do some of these things.
Owen Fitzpatrick: I think next to artificial intelligence, I think China becoming a developed country and having a true middle class is significant because it's so large and so beneficial to the rest of the world. I mean, look at the auto sector in terms of what they've done there in relation to the number of autos that they actually are purchasing.
Owen Fitzpatrick: So it can have a very, very big impact, but I think they have to accept the fact that there are certain rules that come with that. And I think when you go back through history, you can understand why China feels the way that they do in relation to the western world. But I think it's at a point in time now where probably if you just sat down and objectively said, "What makes the most sense?" I think it makes a lot of sense for them to kind of move past what they've been doing and head to the developed world.
Laura Keller: Right, get that diploma as you said. Okay. Well, I feel like we have many more things to talk about. We can't talk all day, but one thing that I wanted to know was a little bit more about this debate of ... you hear investors trying to figure out if they should be more in bonds or they should be more in stocks. So do we come down on that in any one particular way at all to help our audience understand where they should go going into 2019? Anybody want to tee us off for that one?
Jacob Weinstein: I'm the Asset Allocation guy so [crosstalk 00:48:01]
Laura Keller: Yes, that's probably something you should [crosstalk 00:48:03]
Jacob Weinstein: I guess I should probably say something about Asset Allocation. So again, bringing it back to the cycle, having a cyclical view on it and not letting our behaviors get the best of us and hear all these fears and say, "Oh, this is the time I've got to get out of equities." I mean, if you think about every year, every outlook, there's always concerns. There's always risks and if you keep thinking that they're all going to come to fruition all at the same time, you'll never be invested.
Laura Keller: Just keep your money at home.
Jacob Weinstein: Exactly. So thinking about where we are in the cycle, later in the cycle, but low recession risks, that warrants keeping a nice diversified portfolio of stocks and bones. Close to kind of where your long term objective is and not taking very large bets, on size or another. Now we could have inflation, so things that work well when inflation goes higher, like tips, would help diversify some of those risks and hedge some of those risks.
Jacob Weinstein: At the same time, we could have growth shocks. And so therefore interest rates could fall, so some longer duration bonds might be helpful. So there's a little bit of justification to have a little bit of everything right now. Emerging market stocks are a little cheaper, perhaps there. But overall what I'm trying to say is staying diversified, staying the course, making sure you stay on that road, make sure you don't get blown off. It's just very important not to think that all these risks that we talk about and sound so bearish about at times, cause you to de-risk an overall plan. 'Cause once you do that, you may not be able to get back in if you do decide to sell. And therefore, you're out of the markets for several years and before you know it, equity markets have gone up several ten, twenty, thirty percent and you just have this fear of regret that you're just missing out on.
Jacob Weinstein: So staying the course, staying diversified is what I'd say from an Asset Allocation perspective.
Laura Keller: Okay. Owen are you thinking the same things there or are you sort of thinking there's one way up to good returns?
Owen Fitzpatrick: I wish I could disagree with Jake and say that equities are the place to be, but I think it makes a lot more sense today to be more balanced even internationally emerging markets. But also, when you look at fixed income, it's a real return now. And when you look at the way the market has moved, it's telling you that most likely rates aren't headed much higher when you have utilities rallying as much as they have in the last two and a half months. So I do think that having a diversified approach and really branching into other asset classes ... I would be careful on probably credit, on the tail end of the spectrum, just in relation to what we discussed here today.
Owen Fitzpatrick: I think there could be some issues on the lower end of credit.
Laura Keller: Sure, leveraged loans have been called out by the Federal Reserve as having issues. Megan, you were talking earlier about some of the corporate bond borrowing, corporate easy debt that's been happening the last couple of years ... which you know, late cycle might be a problem. Does anyone think we're not late cycle? I guess I should maybe ask before I [crosstalk 00:50:42]
Francis Gannon: I'd say more kind of middle mid cycle I'd say.
Laura Keller: Middle, okay. So we do have some difference of opinion there.
Francis Gannon: I'm not sure. I think you could argue either way and it depends what industry you're talking about.
Megan Greene: Yeah.
Francis Gannon: The only thing I would add about Asset Allocation next year and use the volatility. We know there's going to be more volatility going forward for a variety of reasons, I think which we've all laid out. But there's this thing called 'dollar cost averaging'. Use the volatility, take advantage of it when you have it.
Laura Keller: Right. If you can, yes. And as you say, volatility is something we do expect to just continue happening and perhaps with more gusto than it even has this last couple of months. So I want to just make sure we've had a chance to talk about all different geographies. Does anyone want to weigh in at all on any specific kind of geography. I know we talked about some, but Megan you obviously are looking at Europe a lot and I think Japan is something that you look at as well. Anything that we may want to experience thinking about for 2019?
Megan Greene: Yeah, so as far as Europe's concerned, I've mentioned Italy and the risks there. There are risks certainly to the UK from Brexit. But I didn't mention France.
Laura Keller: Yes, Owen did though, earlier too.
Megan Greene: Yeah, that's right. Or the European Parliamentary elections which are next year. And I can't believe I'm saying this, but I think they'll actually be interesting. They're usually a real non event, but I think this year we'll probably see the center left and the center right continue to fall. And we'll see an increase fragmentation across the political spectrum with French parties picking up more support. And that's only interesting and important in so far as it's a signal for what we can expect in national elections going forward in Europe.
Megan Greene: And so, this kind of fragmentation and governments like the one we have in Italy seem to be here to stay. I think this wave of populism will probably last a while. And if ... I did my PhD dissertation on populism and at the time thought, "When will this ever be relevant?" But actually it's quite useful now when you find there is a correlation between kind of the business cycle and waves of populism. And I think this business cycle [crosstalk 00:52:36]
Laura Keller: And that's what the investors should take away, I think, from it.
Megan Greene: That's right, yeah. And this business cycle's extra long, so it's just given populist parties much more runway to consolidate their support. And I think we're late in the business cycle, but that doesn't mean that it can't last for a long time. So I do think that there is that correlation and we can probably expect more of these populist parties to come to the floor.
Laura Keller: Right, okay. Well I think as we look to wrap up, what I'd like to posit in your mind then would just be one take away from our hour's worth of conversation that we've had today, for our audience. Just one thought if you could narrow it down, just to keep in mind for their planning as far as investing for 2019. And Owen, maybe we'll start with you this time.
Owen Fitzpatrick: Sure, I think we've seen a little bit of panic in relations when you look at flows within the mutual fund world on the equity side and money being pulled out. And I think that's the wrong tact to take. I think from an investment perspective, you have to have to Jake's point, that long term outlook and really commit to an allocation. So I think even though right now it looks like there's a tremendous amount of uncertainty, a lot of it is more macro driven companies in general are in very good shape. I think Frank's brought this up multiple times. When you listen to any type of conference call, industries are in very good shape. We have a lot of debt on hand, but when you look at cash flow it's quite strong. So I think just take a deep breath, take a look at kind of where we're headed in 2019, and I think things are going to turn up and be a lot more positive.
Laura Keller: So your takeaway is investors should keep calm, carry on. Next one, takeaway for 2019, Frank.
Francis Gannon: I think it's the same kind of story in terms of rendering a more normal environment. You're going to see increased volatility, lower returns, but at the same token, a different rate environment which is going to affect how people should approach their asset allocation within at least our world, the small cap space. I think active management is going to have increasingly more importance going forward. There's going to be wider dispersion just because of the volatility you're going to see.
Laura Keller: Right, active management. Okay.
Jacob Weinstein: So recession risks are low, the economy is still growing, and the world is not ending. There are bad things out there that happen, but do not let those overcome you. Be aware of your behavioral biases as people. Markets are scary, but understand that that's that long term plan ... I'll just bring that up and that's very important.
Jacob Weinstein: So from an economics standpoint, business cycle standpoint, as I've said before, just don't expect too much, but at the same time, the cycle can go on for several more years of it like this. It is still kind of slow growing. So stay the course and stay diversified.
Laura Keller: So doomsday message from you, Jake?
Jacob Weinstein: Not yet.
Laura Keller: Yes. And Megan, you get to wrap us up here.
Megan Greene: Yeah. So for 2019, my message isn't significantly different. If I could just wear my Global Chief Economist hat and exist in the [inaudible 00:55:19], I would say the global economy looks very strong. Unfortunately the world doesn't really work like that and I'd say the biggest risks are actually all in the markets and so that's something to watch out for. But for 2019, I think we'll still continue to see a global recovery. This business cycle will last a bit longer.