Paul O’Connor, Head of Multi-Asset, discusses the events that have unfolded in the closing half of 2018 and how these are shaping his team’s outlook.
Global equities fell in the second half of 2018 as markets contended with a heated geopolitical climate. Brexit negotiations lumbered on, and a potential trade war between the US and China troubled both developed and emerging markets. A tanking oil price from October was another cause for concern.
To understand how these events are shaping the team’s outlook, read Outlook: expect surprises
- Brexit dominated headlines; a number of key players resigned their posts and the EU rejected a deal proposal in September.
- Tentative agreement was reached in November, although Prime Minister Theresa May faced a vote of no confidence, which she won. A vote on the deal was delayed.
- The Bank of England raised rates in August but lowered projections for Q4 growth in December.
- FTSE All-Share Index -11.0%.
- The ongoing disagreement between Italy and the European Commission surrounding the country’s budget took a toll on the euro.
- Problems in the Turkish banking system lead to fears of a knock-on effect throughout Europe.
- Exacerbated by Brexit, these concerns contributed to the feeblest growth rate in more than four years.
- The European Central Bank (ECB) maintained its 0% interest rate and confirmed that its bond-buying scheme would end in December.
- FTSE World Europe ex-UK Index -8.1%.
- Despite hitting record highs in the autumn, equity markets were brought low by a major sell-off in the technology sector and trade war rhetoric.
- Nevertheless, consumer confidence rose to 98.3 in December, although business confidence fell sharply to 54.1 that month, the largest monthly drop since October 2008.
- The Federal Reserve continued its tightening path, raising interest rates in both September and December.
- P500 Index –3.4%.
- Japanese markets also fell as GDP expansion plummeted to -6% in Q3 2018, due partly to a run of natural disasters.
- US President Donald Trump threatened high tariffs on automobile exports to the US.
- Shinzo Abe was re-elected as head of his party and the Bank of Japan left policy unchanged.
- FTSE World Japan Index -8.1% in sterling terms.
Asia ex Japan
- Asian equity markets were down, with concerns over the China-US trade war the overarching theme.
- Chinese GDP growth was disappointing as year on year expansion in the three months to end September was lower than expected.
- South Korean stocks plummeted on global worries and a mass exodus of foreign investors.
- Australia’s benchmark index recorded its worst yearly performance since 2011.
- Despite raising its key interest rate to 6.5% earlier in the period, India’s economic data subsequently stalled on lower food and oil prices and mounting international trade tensions.
- FTSE World Asia Pacific ex-Japan Index -5.1%.
- Emerging Markets also generally fell, with the exception being Brazil, whose Bovespa index surged to an all-time high in early December.
- Argentina’s central bank attempted to combat its currency crisis by raising interest rates to c. 60%.
- The Bank of Russia raised rates in September and again in December.
- MSCI Emerging Markets Index -4.9%.
Bonds & commodities
*Bond prices move inversely to yields.Source for all index performance: Thomson Reuters Datastream, 1 July 2018 to 31 December 2018, total return indices in sterling unless otherwise stated.
- Core government bond markets were largely up, with yields falling in the US, Germany and the UK*.
Yields fell in the US on trade war rhetoric and depressed oil prices.
- Worries surrounding a no-deal Brexit scenario sent 10-year gilts to their lowest level in the period ahead of the Conservative Party‘s vote of no confidence, rising later.
- Corporate bond markets fell in local currency terms on worries about rising US interest rates and an economic slowdown.
- The price of Brent Crude oil spiked in October but fell swiftly by the end of the year as Saudi Arabia’s output increased.
- The gold price rose over the six months.
Gross Domestic Product (GDP): a measure of economic activity
Q1, Q2: first quarter of the year, second quarter, etc.
Outlook: expect surprises
2018 was a transition year for financial markets, away from the unusually benign investing conditions of the previous couple of years to a more complicated and uncertain market environment. A central theme of the year was the repricing of risk. Investors were optimistic about equities and other risk assets at the start of 2018 (see chart), having enjoyed two years of strong returns and low volatility. However, they spent most of the year adjusting their expectations to acknowledge emerging risks on the growth, policy and political fronts.
Whereas this widespread investor complacency at the start of last year made us wary of the market outlook then, we enter 2019 encouraged by the fact that many key risks are now more fully priced in to financial markets. While there are plenty of uncertainties overshadowing the outlook our base-case scenario for global macroeconomic fundamentals is still fairly market friendly. We see no reason yet to abandon our expectation of an extended period of economic growth, which should sustain increasing company earnings and maintain a low level of defaults on corporate borrowing. A belief that inflation prospects remain low in the major economies, which should maintain unusually suppressed interest rates for the foreseeable future, is a key assumption underpinning this view of a long market cycle.
Away from central banks, the other big policy question overshadowing 2019 is whether global trade tensions will ease before economic confidence is damaged. We feel market concern on this topic is close to a peak, given that a lot of bad news has already been factored in and that progress has been made recently to de-escalate trade tensions in a number of important areas. Beyond trade, we see plenty of other potential sources of political flare-ups in 2019, with developments in Italy and the UK looking most likely to generate market-moving headlines in the earl months of the year.
With both policy and political uncertainty looking set to be unusually high in 2019, faith in the constructive view for a long market cycle is likely to be frequently tested during the year. We expect most of the major asset classes to deliver better performance in 2019 than in 2018 but we believe that the next few years are general going to see global markets delivering lower and more volatile returns than those enjoyed in the era of central bank quantitative easing.
While buy-and-hold investing was the optimal approach when markets were trending strongly higher, the more turbulent market regime that we anticipate will demand a greater emphasis on volatility management and adjusting asset allocation to suit market conditions. Actively managed multi-asset funds should have plenty of appeal in this sort of environment, given their broad opportunity set, flexibility and diversification.
Investor sentiment: US Bulls vs Bears through market cycles
Source: Bloomberg, December 2018
Actively managed: An active investment approach relies on an investment manager’s skill in making active decisions about which and what proportion of assets to hold, often with the aim of outperforming a specific index. The opposite of passive investing.
Bull vs Bear: 'Bull' describes optimism and rising markets. 'Bear' describes pessimism and falling markets.
Buy-and-hold: An investment strategy where a long-term view is taken, regardless of short-term fluctuations in the market.
Inflation: The rate at which the prices of goods and services are rising in an economy.
Macroeconomic: Relating to themes that affect an economy at large, e.g. Supply and demand, growth, unemployment and inflation.
Quantitative easing: An unconventional monetary policy used by central banks to stimulate the economy by boosting the amount of overall money in the banking system.
Repricing of risk: A reassessment of the risk attached to a given investment, leading to re-pricing that adjusts for perceived changes to its risk profile.
Volatility: the rate and extent of price moves up and down.