What happened in 2018?
2018 was defined by the final quarter, in which we saw UK and overseas equities fall over 10% – and there were few hiding places during the period and the falls experienced wiped out any gains that had been accumulated up to the beginning of October. We have become used to seeing a rally in equity markets in the run up to Christmas, but this year we ended up with the worst December return for global equities on record (since 1988).
The US was the only equity market which held its ground over the year (even if only marginally) with more material losses common across most major markets including the UK (9.5%), Europe (9.6%), MSCI Emerging Markets (9.3%) and Asia Pacific ex Japan (7.3%). In spite of the volatility seen in equity markets, UK Gilts generated a positive return of only 0.6% and even UK credit was in negative territory for the year at (1.6%).
It is worth remembering that we came into the final quarter on the back of another strong earnings season in the US where 77% of companies beat earnings estimates and we were still seeing healthy levels of growth with US Q3 GDP figures finalised at 3.4%, albeit with a slowing trend. This slowing trend is likely to be replicated at a global level but importantly we are still expecting growth to come through – the key threats to these forecasts would be a material deterioration in US / Chinese trade relations, or US interest rates being raised to high too fast.
We are by no means blind to these worries, but it is important to focus on longer term fundamentals as opposed to short term sentiment. In that regard our thematic investment approach is an important crutch at this stage ensuring that we stay focussed on the long-term drivers of change. It is these structural themes that will ultimately drive long term shareholder value as opposed to the shorter-term sentiment that can drive markets both up and down at different stages of the cycle.
What will happen in 2019?
In 2019, we believe there will be five core drivers that will impact our investment universe. The end of 2018 revolved around concerns over global growth and the implications of political rhetoric, notably the US trade wars, and how these impact one another.
Whilst there are a number of concerns over the health of the global economy, our view is it will continue to grow this year, although at a slower pace than we witnessed last year. A recession in the US is unlikely, with a slowdown in growth more likely in 2020/21. In the UK, sentiment will continue to be affected by Brexit uncertainty, with sterling likely to continue to be the barometer of this.
The increased volatility of 2018 is likely to remain and could manifest in a 5-15% correction in global equities at some point in 2019. Unless there is a major shock in markets, we expect this to be short lived with prices recovering as the outlook for company profits looks positive. Political sentiment continues to generate a lot of noise and headlines, with both the US/China trade war and Brexit talks often discussed. It is likely these events will continue to contribute to enhanced market volatility, however our global thematic approach means we focus on companies that we believe will benefit from structural growth over the long term and look through short term noise that surrounds these events.
Finally, we expect there to be a continuation of monetary policy divergence around the globe. As the US continues to increase interest rates and unwind Quantitative easing, we are likely to see pressure points in areas such as Emerging Markets due to pressure from a strong Dollar.
What should Berry & Oak clients look out for?
The enhanced volatility that we expect to see in 2019 creates a number of opportunities for client portfolios. As our portfolios are actively managed, we dynamically manage cash weightings to capture profits and reinvest at more attractive levels. This allows us to react to market sell-offs and buy solid, cheaper assets when growth triggers appear.
Our strategy remains pro-risk, but selectively. As long as political tensions do not deteriorate materially, valuations and profits can reassure investors in 2019. We prefer US and European markets, where we believe valuations are closest linked to earnings growth. As dispersion between the winners and the losers heightens in a volatile market, active stock selection will become more critical.
As the world around us continues to change, such as the advancement of technology or the more efficient use of resources, we expect to see new opportunities to arise. An exciting change we are witnessing is a wider variety of alternative investments come to market to help take advantage of these trends. In the UK, electricity generation was the lowest in 2018 since 1994, despite the fact that the population grew 8% over this time.
What are we doing to protect client portfolios?
We have a number of defensive capabilities within our portfolios to help protect client assets. Towards the end of 2018, we increased the cash weighting in our portfolios. This not only provides us better protection in a falling market, but also means we can reinvest at a more attractive entry point.
In an environment of rising interest rates and monetary tightening, we are maintaining our underweight bond and overweight alternative positioning. Bonds are likely to be under pressure as the historic correlation with equities breakdown, meaning we believe there are better sources of return and protection in other asset classes. In contrast, alternatives have shown during the end of 2018 that during periods of market stress they offer good levels of protection to portfolios, whilst often offering inflation linked income.
Finally, we continue to utilise derivative protection in our pooled solutions where appropriate to help protect portfolios if there are sudden and steep drop in markets. We are looking closely at various options available to us in April this year to try and manage a potential increase in volatility at this time.
Whilst these actions can help to manage volatility in the short term, it is important to retain a long-term outlook for the portfolio. We believe our thematic approach, focussing on companies that will benefit from structural drivers of change, will outperform over the long term.
*Past performance is not a reliable indicator of future results
Article Credit – Charles Thompson – Standard Life Wealth