2018 proved to be a difficult year for investors with a period of expansion in most global equity markets and other assets coming to an end, abruptly in the case of equities. All-time highs for the US and UK markets in September and May respectively and record values for leading technology stocks rapidly reversed in the final quarter as investor sentiment shifted to focus on risks to markets.
These have included:-
- The tightening of monetary policy, in the US where the reversal of quantitative easing and rises in interest rates are well advanced in response to healthier economic growth and full employment
- A new populist government in Italy revived eurozone tensions
- Brexit related worries have continued as a deal acceptable to the UK Parliament remains elusive
- Increasing trade tensions between the US and China
Alongside this, expectations for economic growth rates have declined with some interest rate sensitive areas of the US economy such as vehicle sales showing weakness and signs of slower expansion in China and the eurozone. Rather than signalling imminent recession, the current consensus is that much is a reflection of the late stage of the economic cycle, particularly in the US, which has been exacerbated by the other factors highlighted.
Global economic growth is still forecast to be positive in 2019 and there are reasons to believe that a ‘soft landing’ is possible with unemployment in the US at a 50 year low and a similar picture in the UK. Inflation remains steady and the possibility that slowing economic growth in the rest of the world will enable the US Federal Reserve to pause monetary tightening is likely to receive a favourable response from markets.
While it is inevitable that Brexit is a cause of concern to UK based investors, the returns from US, European, Asian and developing stock markets illustrate that global factors are of greater significance. The political situation in the UK is of course evolving rapidly and it is impossible to know whether there will be concessions resulting in Parliament reluctantly passing the Prime Minister’s Withdrawal Agreement, the tabling of a second referendum or allowing a ‘no deal’ exit on 29 March. Sterling has been the main barometer of the market’s view towards Brexit and it is notable that the change in value has been limited recently; an increased likelihood of a ‘no deal’ exit would be expected to see a significant decline.
The uncertainties over Brexit have nevertheless impacted sectors of the UK market where there is a greater focus on the domestic economy resulting in what may prove to be attractive longer term valuations for selected companies including housebuilders, financials and retailers less vulnerable to shifting consumer trends.
The market declines in both the UK and overseas mean that stock market valuations generally have fallen, quite sharply over the past three months. Provided recession is avoided though, this may provide some room for equities to recover if earnings expectations are at least maintained. A resolution of the trade policy issues between the US and China and an earlier end to the cycle of rising interest rates in the US would also create a more favourable environment. Markets have focused on risks recently but the potential for recovery upon more positive news should certainly not be ignored.
Volatility is likely to remain higher than average as the transition from loose monetary policy over the past nine years, continues. Nevertheless, alongside other diversifying assets UK and overseas equities remain a key element of longer term investment portfolios. Attempts to time the market and sit out periods of weakness generally fail, with not only a decision required on when to exit the market but then when to re-enter.
Portfolio rebalancing through an element of active management and diversification is typically a more effective approach provided there is tolerance of the risks involved and a suitably longer term timescale. In the current environment, this includes a focus on relatively defensive stocks with the ability to sustain above average levels of dividend income, businesses with limited or no debt and those less reliant on strong economic growth. A global approach remains important, also providing a potential benefit in the event of further depreciation in the value of sterling.
Away from equities, good quality fixed income exposure where the risk from the credit side i.e. possible default is limited, should be valuable. While the environment remains relatively challenging due to rising interest rates and modest nominal return potential, this asset should offer safe haven qualities as demonstrated in 2018 when UK government bonds, achieved a positive return with notable strength over the last quarter.
Although offering no income yield and only likely to form a modest element of a portfolio, gold can provide protection in more trying economic conditions. Assuming that interest rate rises are limited, income generating assets such as infrastructure where there should be an element of inflation proofing, have performed well recently and offer returns with a lower degree of correlation to equity markets.
Short term projections for financial markets are futile but after a prolonged period of expansion, it is inevitable that a period of slower growth will occur as a natural consequence of the economic cycle. There are specific risks which at the moment are difficult to quantify including Brexit and trade policy matters but there is potential for meaningful recovery if these issues can be resolved. With inflation across the developed economies reasonably stable, the banking sector strengthened in the aftermath of the financial crisis and stock market valuations not expensive by historic standards, there is no reason to doubt that the long term benefits of equity investment will eventually come through. Strategies should certainly aim to mitigate some of the risks however through active management and diversification.
2018 Investment Market Total Returns
|Market Performance||2018 Total Return|
|FTSE World ex-UK||-2.68%|
|FTSE Actuaries UK Conventional Gilt All Stocks||+0.57%|
|FTSE Actuaries UK Index-Linked All Stocks||-0.28%|
|Key Rates||2018 Total Return|
|Bank of England Base Rate||+0.75%|
|Inflation (Retail Prices Index) *||+3.20%|
* November 2018