Investment Review 2018

2018 was clearly a tougher year for markets than investors have got used to since the global financial crisis and before looking forward, we need to examine why things have played out as they have.

Broadly speaking, last year was the opposite to 2017 – during which equity markets appeared to be in an ongoing race to post fresh highs month after month – and proved a challenging period for active fund management and, indeed, running multi-asset portfolios.

Most asset classes posted negative returns over the last 12 months, after a decade largely in the black, and we saw a rare case of fear and greed joining forces to drive markets. One or the other is typically in the ascendancy, creating the cycle as the mood shifts between them, but while the US saw plenty of greed in 2018, at least until October, fear stalked the rest of the world.

American growth led the way for a variety of reasons, including Trump’s tax cuts and drive for a ‘better deal for the US’, a stronger dollar, and the large skew towards fast-growing FAANG (Facebook, Apple, Amazon, Netflix and Google) businesses. To give an indication of how much technology influences the US market, the sector makes up around a third of the S&P 500, compared to 12% in Japan, 7% in Europe and less than 1% in the UK.

Moving to the fear side, dollar strength was a major culprit behind a difficult year in emerging markets and Asia although, as we have said before, correlation no longer equals causation in terms of this relationship. While there are clearly certain emerging markets with more serious structural problems – Turkey, Argentina and South Africa – we believe the region as a whole is fundamentally solid and have used recent weakness to top up exposure at cheap levels.

As for Europe, no one needs reminding how the long-running Brexit situation is affecting the UK while politics also dominated the Continent after a quieter 2017, encapsulated by the budget situation in Italy and President Macron having to make major concessions after the ‘gilets jaunes’ riots in France.

Meanwhile, the oil price posted one of its more volatile years, with Brent Crude climbing into the mid $80s before shedding close to a quarter and settling around the $60 mark. Oil, or commodities more generally, was one of the three Cs – alongside central banks and China – we felt would dominate sentiment in 2018 and that trend looks likely to persist.

While the European Central Bank (ECB) has committed to no rate rises until at least summer and UK policy is frozen in Brexit limbo, the Federal Reserve was most aggressive in policy terms with four hikes over the year. While more are still expected, recent market selloffs and – despite Presidents traditionally avoiding commenting on monetary policy – ongoing criticism from the White House have led to questions on whether the Bank will maintain these plans.

A couple of speeches potentially hinted at a slight softening in approach. In November, Fed Chair Jerome Powell said rates are currently just below the range officials consider neutral. This came just a month after he claimed the Fed was ‘a long way off’ neutral, comments that many believe played a large part in the ‘Red October’ falls. Powell also stressed the Bank has no pre-set policy path and will determine its moves based on what incoming economic and financial data dictates.

Alongside its final hike announcement in December, Fed officials said they now forecast two rises in 2019, down from the three previously projected, although continued to stress that further “gradual” increases are appropriate.

Our other C, China, also remains central to global growth, both in its own right as the world’s second-largest economy and as part of the ongoing trade spat with the US. After trade concerns dominated sentiment for much of last year, we got some respite in November when Trump met his Chinese counterpart Xi Jinping at the G20 summit in Buenos Aires and the pair thrashed out a 90-day ceasefire. This will end in the coming weeks and we can only hope policymakers have made meaningful progress to avoid a resumption of hostilities.

So given all that background – and on the usual basis that our crystal ball is no clearer than anyone else’s – what can we expect in 2019? At the most basic level, we believe financial markets are driven over the long term by the path of global growth and global inflation so on a macro level, we are simply trying to work out whether things are getting better or worse.

Based on Sir John Templeton’s quote that “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria,” we believe the US is at stage three – and potentially well through that – and the rest of the world is still at two. We are therefore looking for better news from outside the US and with Europe, at least for now, tied in up politics, impetus may have to come from China.

As stated, the country’s relationship with the US will be a huge factor in global markets over the course of 2019 but we would also expect the government to stimulate its economy if it is to continue to grow around the 6% level.

On the inflation front, we came into 2018 with wage growth higher than expected and that was a large factor behind the sell-off in February. Looking forward, oil prices are a key factor and we would suggest a lower level around the current $60 is fairly favourable for risk assets.

Japan has been something of a forgotten market in recent years, with little political scandal and a fairly positive trade relationship with the US, and as the country is a major beneficiary of lower oil prices as an importer, we feel it could surprise on the upside. Elsewhere, Brazil and Russia of the Bric quartet tend to benefit from stronger oil and India and China from weaker, so ongoing muted prices could be another spur for the latter.

Of course, no outlook can sidestep the toxic Brexit, with the situation seemingly settling into an impasse: Theresa May has survived a vote of no confidence but cannot get her deal through parliament and the EU seems unwilling to grant any concessions. We are now in a position where even the one certainty in this situation – that the UK would leave the EU on 29 March 2019 – is no longer definite and all possibilities, from no deal, May’s deal, extending the deadline and not leaving at all, appear possible.

Economically speaking, what we can say is that a harder Brexit scenario would lead to weaker sterling, softer gilt yields and a better environment for large caps over small, and a softer Brexit the opposite – but unlike the vote itself, this is nothing like a binary call.

As stated, 2018 was tough for active management as smaller companies underperformed and it remains to be seen whether conditions are more conducive in 2019. We introduced a value tilt to our portfolios at the start of last year and that trade started to bear fruit in the latter months – although again, we will have to wait and see whether that is a temporary phenomenon or the start of a longer-term shift.

Over the years, an environment of rising interest rates has typically been good for value stocks and with election campaigning cycle again in the US, we expect to see some of the growth names, particularly the FAANGs, come under renewed political fire.

Overall, while we are moving through the market cycle, leading indicators do not yet point to the risk of imminent recession and global economic growth in 2019 should still surpass the post-financial crisis average. We think this suggests earnings and share values have room to advance. As ever, we continue to favour cheaper markets – still emerging markets and Asia at present – and prefer equities over bonds on a yield argument if nothing else. The ten largest companies in the UK currently offer an average yield close to 5% and that seems a fairly compelling entry point however you feel about trade wars or Brexit.

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