2018 presented a tricky, volatile environment for investors, and most asset classes fell in the year. The FTSE All-Share retreated almost 13%. Sentiment regarding the global economy and stock markets deteriorated from an optimistic start. Early in 2018, the price of Bitcoin peaked, a demonstration of the appetite for speculative assets, but by the end of the year global investors were seeking safe havens such as government bonds and cash.
There has been increasing concern over the outlook for the global economy, with specific focus on US trade tariffs and the effect they are beginning to have on global trade. Meanwhile, the US Federal Reserve has continued to increase interest rates, and more hikes are expected in 2019. In Europe, tension escalated between the European Commission and the Italian governing coalition over a final budget, and of course Brexit negotiations deteriorated.
However, setting aside these concerns, the fundamental outlook for the global economy appears benign, with economic growth slowing but still above the historic trend, and multinational companies growing their earnings resiliently. Furthermore, a positive aspect of the market weakness is that expectations have now been reset and asset prices across equities, bond and property markets offer better value.
Given the challenges that 2018 presented, it is worth taking a step back to assess the state of the global economy and key markets, and our investment strategy:
The flow of money & interest rates
It has now been almost 10 years since the market low (March 2009) in the midst of the global financial crisis. Over the last decade central banks around the world have been pushing liquidity into the global financial system, known as quantitative easing. The reversal of this process has only just begun and it was always going to cause a headwind to economies and markets.
Meanwhile, interest rates are rising. It is difficult to judge how individuals, companies and governments who have become accustomed to historically low interest levels will manage higher borrowing rates. However, central banks are likely to be vigilant for signs of economic shock and will exercise caution in terms of the pace of interest rates rises. In addition, capital reserves at retail banks are much stronger than they were before the financial crisis, so they are well structured to cope should another credit crunch rear its ugly head.
In general however, the contraction in liquidity has put pressure on markets, and this will continue into 2019.
US monetary policy and US trade policy are likely to remain focal points for investors this year. The US economy is operating at full capacity, generating growth at 2-3%, but the effect of Trump’s fiscal stimulus is expected to fade around the middle of 2019. However, a recession is not currently a credible threat, and inflation is unlikely to rise fast enough to cause the Federal Reserve (Fed) to raise interest rates faster than currently projected. Indeed, a slowdown in the US economy may lead the Fed to surprise markets by slower interest rate rises, which may also weakening the dollar, boosting demand.
Europe & UK
In contrast to the US, there is a real risk of recession in Europe, with the global trade concerns damaging confidence in the export-led market, combined with domestic challenges. However, the main concerns may well ease during the first half of the year. Italy has helped by cutting its budget deficit plan enough to appease the EU, and an end to the Brexit shenanigans would boost sentiment.
The outcome of Brexit is anyone’s guess, but any reasonable settlement for the UK would bring an investment and consumer boost as confidence returns. Large UK stocks are multinational and therefore somewhat immune, while medium size domestic UK companies remain sensitive. We would expect a rally in these assets in all but a no-deal scenario.
For sterling, if the UK falls out of the European Union without a deal or transition agreement, further weakness is likely in the short term. However, the uncertainty is firmly priced into markets, so even a weakly positive outcome should proffer sterling a boost.
2019 is set to be another year of uncertainty and volatility. A great deal depends on political developments that are of course impossible to predict. This political uncertainty will continue to weigh on corporate and consumer sentiment and this will in turn impact global growth projections, which were already being moderated due to tighter monetary conditions. However, we expect a global slowdown, not a recession.
In times of increased uncertainty we are duty bound to stick rigorously to our investment philosophy. Our portfolios are internationally focused, so Brexit really isn’t a consideration apart from the regular swings in sterling. However, we must be wary that multinational companies rely on global trade and will be affected by both tariffs and lower global economic growth. Mitigating this risk, our strategies prefer companies that maintain low levels of debt and can withstand tougher economic conditions.
Following the market falls, company valuations are lower, and in some cases are now attractive. If the political challenges, risks and uncertainties recede, markets may well surprise positively.