US Capital Markets Face Uncertainty Entering 2019, With Volatility Likely to Continue

Skadden's 2019 Insights

Michelle Gasaway Benjamin K. Marsh Agnes N. Aniol Jeremy A. Zucker

Performance in the U.S. capital markets was mixed in 2018, with the equity new issuance market showing strength through most of the year and the debt issuance markets softening.1 The initial public offering (IPO) market had its strongest year since 2014, though it weakened in the fourth quarter due to significant market volatility. In 2019, the U.S. economy is forecasted to continue to grow, albeit at a slower pace, and most economic indicators remain sound, with an unemployment rate of 3.9 percent and 312,000 jobs added in December 2018. However, ongoing concerns over interest rates, domestic and geopolitical events, trade and the decelerated pace of global economic growth could cause further market volatility.

2018 Debt Markets

2018 Equity Markets

Looking Ahead

The U.S. economy enters 2019 in its ninth year of expansion, with stock markets on pace to eclipse the bull run of 1991-2001 as the longest in history. But whether the capital markets are capable of continued strength depends on several factors.

Economic Growth. The U.S. economy expanded at an accelerated pace in 2018. U.S. gross domestic product grew 3.1 percent, marking the first year since 2005 that the economy expanded above 3 percent. The strength was driven by increases in government spending, healthy corporate profits and increases in consumer and business spending. The U.S. dollar rose in value 4.3 percent in 2018, according to the U.S. dollar index, demonstrating positive sentiment toward the U.S. economy.

Many economists expect the pace of U.S. economic growth to moderate in 2019. While a reduced economic growth rate does not necessarily mean a recession is imminent, it could negatively impact stock prices and corporate earnings, and reduce investor confidence. Nevertheless, many economists have indicated that a recession in 2019 is unlikely, and investment banks remain generally bullish on the near-term outlook for capital markets activity. However, the longer the government shutdown lasts, the more pressure there is on some of these forecasts.

Corporate Earnings. Moderating earnings growth could present challenges to capital markets activity, with a forecasted decline from 9 percent in 2018 to 7-8 percent in 2019. However, with S&P 500 multiples at five-year lows, arguably the market already has adjusted prices in anticipation of a slowdown. Stronger-than-anticipated earnings growth could improve investor confidence and slow recent market declines, facilitating activity as issuers seek to take advantage of rising valuations. On the other hand, weaker-than-expected earnings could contribute to market volatility and dampen capital markets activity.

Trade Uncertainty. The ongoing U.S.-China trade dispute could continue to disrupt activity. To date, the U.S. and China have imposed $250 billion and $110 billion worth of tariffs, respectively, on the other country’s products. (See “Enhanced US Export Controls and Aggressive Enforcement Likely to Impact China.”) Although a temporary “truce” was reached in December 2018 (including a 90-day pause on tariff hikes until March 1, 2019), an array of challenging trade issues remain unresolved. Until a final resolution is reached, the existing tariffs and continued uncertainty over U.S.-China trade relations may negatively impact business investment and consumer confidence. Moreover, other trade matters, such as the effects of the renegotiated North American Free Trade Agreement and tariffs on certain imported products (e.g., aluminum and steel) could also weigh on the markets.

Federal Reserve Activity. The monetary policy of the Federal Reserve impacted the capital markets in 2018 and could continue to do so in 2019. Under the new leadership of Jerome Powell, the Federal Reserve increased the federal funds interest rate four times in 2018, most recently in December 2018, from 2.25 percent to 2.5 percent, and continued to pursue its plan to reduce the Fed’s balance sheet (most recently at a pace of $50 billion per month). However, Powell more recently indicated that the Federal Reserve will be patient with monetary policy as it watches economic performance. From a capital markets perspective, higher interest rates can reduce existing bond prices and make new bond issuances more expensive for issuers. In addition, market volatility from Federal Reserve activity and policy statements may lead to tighter and more unpredictable windows of opportunity for capital raising.

U.S. and Geopolitical Events. Political uncertainty both in the U.S. and internationally has significantly impacted the capital markets in recent months. On the domestic front, according to The Washington Post, White House tweets have moved markets by as many as 3 percentage points in a single trading session, such as when faltering trade relations with China were revealed on December 5, 2018. Meanwhile, the longest government shutdown in history effectively closed the IPO window in January 2019. Additionally, even when the government reopens, IPO companies with a calendar year-end would need to price their offerings by February 14, 2019, if they want to go effective without providing 2018 audited financial statements. A prolonged government shutdown could have implications for the IPO market for the full year, as the SEC and issuers work through the pent-up backlog, and could potentially have broader economic effects if it impacts business investment and consumer confidence. Other elements of domestic politics may also continue to disrupt markets in 2019, with a survey by a bulge bracket financial institution finding that individual investors perceive the White House to be the greatest source of market risk in 2019. Political uncertainty outside the U.S. also may impact the markets, including Brexit and trade disputes, in addition to changes to foreign direct investment rules across Europe (see “Foreign Investment Control Reforms in Europe”) and sanctions (see “Key Developments in US Sanctions”).

Equity Markets in 2019

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1 Sources for the data in this article are: Bloomberg, Business Insider, Dealogic, Deloitte, Moody’s, Nasdaq, The New York Times, PitchBook, PwC, Russell Investments, Seeking Alpha, Thomson Reuters, UBS, Vanguard and The Wall Street Journal.

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