What happened in 2018 and more importantly why?

There can be no denying that 2018 was not a good year for equity markets or indeed bonds. To know why this is the case we need to look at the longer-term performance and also, as important, what happened in the last quarter of 2018. 

Looking back to the financial crisis of 2008 equity markets saw their low at the beginning of 2009 and since then, even accounting for the sharp falls in the last quarter the FTSE All-Share index in the UK has more than doubled. Looking at the S&P Index in the US this is closer to a rise of 200%. Over this period there were also periods of very low volatility. For example in 2017 the peak to trough on the FTSE100 was a maximum of 4%. The average fall from peak to trough on the FTSE100 is 15%. In layman terms every year, on average, the FTSE100 will fall by 15% from its high, 2017 was exceptionally calm. Therefore, what we saw in the last quarter of 2018 could be put down to an overdue correction after a particularly calm period for markets. However, the final quarter of 2018 was more than this, it was a number of events, not all connected, that led to a harsh correction.

The majority of corrections in both equity and bond markets are related to interest rates increases. In December the US Fed increased interest rates for the fourth time in 2018. This was not the actual news, markets expected this, but it was the statement by the Fed Chief Jerome Powell that spooked markets as he gave no indication that this would be the last increase in interest rates for a period of time. Markets were hoping that there would at least be a pause in interest rate rises or a signal that they had reached their peak. Mr Powell was Donald Trump’s (yes, him!) choice as the Fed chairman but in recent weeks Mr Trump has been very critical of him, stating that he doesn’t understand equity markets and that he was choking the American economy of its growth by increasing rates too fast. This uncertainty sent markets into reverse.

The second major factor was Donald Trump’s trade war with China. Trade wars hurt trade which in turn causes an economic slowdown, in this case in both China and the US. An example of this is the trading update from Apple today, which saw much slower sales growth in China. Again this uncertainty has pushed markets lower as although there were a number of positive tweets from Mr Trump, there has been no material developments and the arrest in Canada of the Huawei (a Chinese mobile company) Finance Director, who also happens to be the daughter of the founder, did not help. It will be interesting to see whether Trump insists on her being deported to America or a deal is made and she ends up back in China.

Although possibly not as significant the US federal government shutdown over the Christmas period impacted on investor confidence and the low volumes over the shorter Christmas opening times saw larger than usual market moves in the US. The UK markets, by comparison, were relatively calm.  

The third major issue was closer to home and was a negative for UK markets rather than global and that, of course, was Brexit. I would like to be able to tell you what is going to happen, but unfortunately I, like almost everyone else has no idea. What I can say, however, is that all the uncertainty we are seeing is not good for markets and the closer we get to a No Deal the worse it will be.

getting the crystal ball out – what do you think will happen in 2019

These three main issues led to a very poor performance from equities in the final quarter of 2018 but where do we go from here. Given the above, global growth will slow in 2019, it is unavoidable. Tighter monetary policy and political uncertainty will weigh on consumer sentiment, although we believe it will be a slowdown rather than a recession with US monetary policy and US trade policy likely to be the key drivers of sentiment. Although Mr Powell wants to look independent of Mr Trump he would be very foolish to ignore him completely and with markets where they are now it does seem very unlikely that we will see more increases in US interest rates in the near term. Regarding the potential trade war with China, this is not only hurting China but also the US consumer and with US elections less than two years away Mr Trump will be very aware of this. The president believes that strong stockmarket levels are a good sign that he is doing well, he will not want to jeopardize this. It is very difficult to be able to predict what will happen with Brexit, although ultimately it should not have that much of an impact on global markets.

Given the falls that we saw in the last quarter and the reasons for them we can see a reversal of this and especially if we see some concrete evidence of talks between China and the US and a more helpful tone for markets from the US Fed. What will continue, however, in the short term is volatility. Liquidity could also be an issue as Quantitative Easing comes to end. What clients should, therefore be looking for is evidence of an easing of trade tensions and a more friendly interest rate environment, mostly from the US. Any good news on Brexit would also be helpful and whatever a persons view, as far as markets are concerned they would prefer another vote to leaving.

    1. What steps are you taking to protect client portfolios, while still participating in any potential upside.

With regard to clients portfolios, diversification is, as always, the key. We have tried to protect clients from the worst of the falls although this has been quite difficult as most areas of the investment market have fallen, although some of the Alternative sectors have performed well or held their value. Quality will always win in the end as will long term investing and markets/ portfolios should not be judged over the short term. It is also good to remember that the last time we saw falls such as the one in quarter four of 2018 was the financial crisis of 2018. We are a lot further on from then and we have a strong banking system compared to the near global financial crash that we saw in 2008. From here, although volatile, we could be in a good buying environment.”

*Past performance is not a reliable indicator of future results

Article Credit – Paul Stevens – Gore Brown Investment Management

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