Our Reviews look back at the markets over the last quarter as well as our thoughts on today's major issues.
There is little doubt that 2018 was both a challenging and disappointing year for investors, especially against the backdrop of the strong returns achieved in 2017. The table below shows the returns for both years as well as over shorter time periods, for sterling-based investors.
|Asset Class||3 Months||6 Months||1 Year||3 Years|
|FTSE All Share||-10.3 %||-11.0 %||-9.5 %||13.1 %|
|S&P 500||-11.6 %||-3.7 %||1.0 %||10.6 %|
|FTSE World Europe ex UK||-10.9 %||-8.1 %||-9.5 %||17.5 %|
|TOPIX||-12.9 %||-8.9 %||-8.6 %||15.6 %|
|MSCI Asia ex Japan||-6.5 %||-6.8 %||-9.1 %||29.5 %|
|MSCI Emerging Markets||-5.3 %||-5.1 %||-9.3 %||25.4 %|
|UK Gilts||-1.9 %||0.2 %||0.6 %||1.8 %|
|IBOXX Sterling Corp Bond||-0.2 %||-0.4 %||-2.2 %||5.0 %|
|MSCI UK Monthly Property||0.8 %||2.5 %||7.2 %||11.2 %|
|Brent Crude Oil (US$/bl)||-33.0 %||-28.3 %||-9.6 %||4.4 %|
|GSCI Commodities Index||-21.1 %||-19.1 %||-8.5 %||-3.4 %|
|Gold (US$/ounce)||9.8 %||5.6 %||3.2 %||3.0 %|
Source: FE Analytics - rebased in Pounds Sterling
Following a strong start to the year, early February saw global equity markets suffer a sharp correction as investors feared that US inflation was on the rise, leading to an increase in interest rates and placing at risk the economic growth outlook. But this was relatively short-lived and, despite the start of a trade war between the US and China, the six months between April and September saw very strong gains from equities, with only the Emerging Markets sector failing to generate a positive return.
Early October saw global stock markets come under pressure and there was a widespread sell-off, largely on fears of escalating trade tensions, rising US interest rates and rich US share valuations, especially in the technology sector. Given that these issues had been present since earlier in the year, it seems most likely that investors had become scared about the prospects for future growth, and so the big question was whether this was a just temporary pullback akin to that of February, or the start of a more pronounced correction.
Unfortunately, it was the latter and the last three months of the year was a period of significant damage such that none of the major equity markets managing to deliver a positive return in 2018 (in sterling terms).
At the beginning of 2018 all the talk was of synchronised growth in the global economy, but as the year progressed this shifted to what can be described as cyclical divergence. But in acknowledging this, we believe that ‘market noise’ is mostly to blame rather than a shift in the fundamentals of the macro-economy.
Certainly, the strength of the US economy, boosted by tax cuts, cultivated fears of excessive US policy tightening leading to further strengthening of the US dollar with all its ramifications. Add to the mix higher oil prices, and Asia Pacific and Emerging Market economies were caught in a ‘perfect storm’ of falling asset prices and deteriorating fundamentals.
But the noise covered a far wider spectrum of issues including fears over inflation, trade tensions – most importantly between the US and China, Brexit, and political uncertainty in Europe to name but a few. Rather like a revolving door, each of these factors has periodically captured the headlines, but it could be argued that it is the President Trump’s somewhat hostile approach to global trade that created much of the disappointment in economies and asset markets in 2018.
There is little doubt that the global economy is losing steam. Recent data and business surveys from a broad spread of economies support this view, but, as yet, there is little evidence to suggest that a recession is imminent.
Although global inflation has been creeping higher it is, for now, contained, with lower oil prices beginning to act as a drag on headline inflation and likely to limit the extent of future increases in interest rates. Recently, in an effort to bring some calm to the markets, Jerome Powell, the Chairman of the US Federal Reserve Board stated ‘…….the Fed would remain patient and flexible if slower economic conditions warrant fewer rate hikes’. Influencing the Fed’s policy will be the extent to which the US economy slows as the impact of President Trump’s tax cuts fades.
In early 2018 growth in China slowed due to weaker infrastructure spend and this led the authorities there to ease policy. For some time now, China has been trying to balance looser monetary and fiscal policy to stimulate growth in the economy with the high levels of debt in the corporate sector. What happens in China matters; it is the engine room of the economies of the Far East and is the world’s largest consumer of commodities. The current trade tension with the US is of global economic and market significance, as it is aggravating an already slowing economy, perhaps explaining China’s willingness to meet the US at the discussion table. Interestingly, Chinese exports have held up well despite the imposition of trade tariffs and it is domestic consumption which is currently downbeat.
Although the US-China trade talks are to be welcomed, the areas of dispute are wide and complex and so the talks are likely to be protracted. However, if the 90-day deferment of increasing the level of tariffs is extended beyond March the markets will take some comfort, just as they have from the Fed’s recent softer tone about the future trajectory of US interest rates. Whatever happens with US interest rates and China’s growth will significantly influence the emerging economies sector in 2019.
Here in the UK we still sit under the Brexit cloud with significant implications for both the UK and continental Europe; for everyone’s sake closure will be welcomed. Clearly, the UK economy has been shackled by the uncertainty over our future relationship with the euro-zone, and the political landscape within the UK looks fragile at best, with some change inevitable even if the Conservatives manage to cling on to power. But the euro-zone is not without its problems both economically and politically, and irrespective of Brexit.
Germany, the industrial powerhouse of the European economy is currently struggling, with dismal industrial production data raising concerns that its economy could have contracted in the last quarter of 2018. Weakness is evident in the auto, energy and construction sectors of industry. Although the euro-zone’s corporate earnings are forecast to grow at 9.2% in 2019, a catalyst in the form of rising yields or inflation may be necessary to cause investors to begin to love European equities again. Neither is thought likely in the short term and with the changing political landscape it is challenging to be too positive except on a long-term view.
At the time of writing the markets are in a more positive mood, but it would not take much for them to become unsettled again; uncertainty never seems far away. This creates a complicated environment for risk assets given the outlook for global growth and despite a background of reasonable corporate fundamentals (in most sectors).
The challenge is to find growth at a reasonable price and this generally means backing global equities rather than global bonds. Unfortunately, and especially in the current climate, this means accepting the likelihood of episodic bouts of heightened volatility. To dampen the potential for volatility a balanced portfolio should diversify away from equities by including some exposure to other asset classes, including fixed interest, ‘alternatives’ and cash.
But we would counsel against any dramatic shifts in asset allocation given the current outlook. If the black clouds come back then longer-dated US government bonds (Treasuries) may offer upside, given that the Fed will at some point stop raising rates and the focus will turn to rate cuts. Conversely, if the US and China reach some form of agreement investors’ risk appetite will return, especially now that prices are cheaper after the recent sell-off. The focus would then be on the strength of the US economy and the return of worries over inflation, which would hurt bonds.
Sheltering in corporate bonds over equities also carries risk, not least because of the rise in corporate indebtedness that has accumulated over the last decade.
If you exclude US equities (and even these are cheaper than they were for most of the second half of 2018), equities still generally look good value. In the UK for example, the FTSE 100 dividend yield is currently around 4.5% compared to a somewhat paltry 1.3% on 10-year UK gilts (government bonds). Certainly, we expect the gap between these two to narrow with time, but this seems a fairly compelling entry point irrespective of Brexit or trade wars.
Elsewhere, we believe that Asian and emerging market equity valuations look increasingly attractive. We believe that the confluence of factors that combined to push these markets lower in 2018 are unlikely to persist in 2019. These were the European Central Bank reducing its bond-buying programme, the US Federal Reserve shrinking its balance sheet and interest rates rising around the world, which have led to a strong US dollar. This is all against a backdrop of the escalation of a trade war between the US and China. Given that we do not expect US interest rates to rise as frequently as they did in 2018 the US dollar is unlikely to strengthen as much, and hopefully there will be a positive outcome of the current trade talks between the US and China.
So, except for the most cautious of investors, we continue to favour equities, but it seems sensible to seek more defensive positions through the choice of investment funds selected for inclusion, especially in the core element of the portfolio. Furthermore, it is essential to maintain an appropriate investment time horizon.
In the November portfolio rebalance we reduced the exposure to equities in the majority of the portfolios within the Parallel range. The capital released was reallocated, either to Cash, or to funds which we classify as ‘Alternatives’ where the potential return is greater than Cash and to provide lower correlation with equities.
We trimmed our exposure to the UK, Europe and Japan, sold our entire position in two UK equity funds and added one new UK equity fund, substituted one of our fixed interest funds with a fund from a different fund manager, and made several changes to the percentage exposure to the residual investment funds.
Given the current outlook, we are content that our asset allocation is broadly appropriate taking account of the investment objectives of each of our portfolios. However, we are disappointed in the performance of a relatively small handful of the underlying funds, and the extent to which they were punished in the turbulent markets in the last quarter of 2018. This reflects the concentrated nature of some of the investment funds, the manager’s investment style and approach not suiting the current stage of the cycle, and the somewhat indiscriminate sell-down of the market as investors sought to de-risk.
Consequently, we expect to make some further changes in the very near future to capture some of the views expressed in this quarterly update and these will be documented in our next briefing.
Risk warning: Investors should be aware that past performance of investments is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them may fall as well as rise. The content of this bulletin is for general information and reﬂects the general market view of Parallel Investment Management Ltd. - it should not be interpreted as recommendations or advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of the content.