- Investment Insight
- 5 minute read
By Nancy Curtin
Given the volatility in markets, we are cognisant that clients may be feeling uneasy. Here is an update from our Investment Team.
Market swings have been large and news flow over the final quarter of 2018 (and particularly December, the worst month for the US equity market in 50 years) has been quite unnerving.
The litany of concerns relate particularly to fears of economic growth deceleration, particularly in the US and China, the world’s largest economies, on the back of tighter liquidity conditions. Brexit, trade tensions and Trump tantrums have further worried investors. Slowing economic growth, together with the unknowns around trade, fears of rising inflation, and higher US interest rates will cause volatility to remain high in 2019, especially during the next few months. Importantly, these concerns will not be eliminated quickly.
However, we believe that now is the time to stay calm, not to trade the market but to remain invested, and to remember that the best rewards accrue to long-term investors.
Market sentiment is currently very negative (a contrarian signal), but as witnessed last Friday, positive news flow can change the direction of markets and sentiment quite quickly. Four important things happened on Friday.
- December US job creation data came in strongly at 312,000, with a rise in the participation rate, signalling more workers in the economy are being employed – a reminder that while growth in the US may be slowing, it is still healthy.
- Federal Reserve Chairman, Jerome Powell was also upbeat about US growth, and importantly indicated that the Fed would take a patient approach to further tightening, and that he was listening to market concerns and will remain data-dependent going forward. This has been interpreted as a dovish signal.
- The US and China agreed to start trade talks, with both China and the US signalling a strong desire to find a way forward through the three month truce on tariffs, a positive start to negotiations.
- China cut the reserve requirement ratio by 1%, releasing $117bn of liquidity into its banking system as part of a series of fiscal and monetary stimulus measures to support the economy.
While risks remain, these announcements demonstrate just how quickly a positive signal in policy can impact markets.
One of the themes worth highlighting is that markets are often counter-intuitive, the worse the news, often the better the investment outcome and vice versa. Consider:
- 2017 started out with muted expectations and surprised on the upside: economic activity recovered, earnings growth accelerated and valuations were supportive, leading to excellent returns with low levels of volatility. In a sense, the strong returns of 2017 stole from gains of 2018.
- 2018 started out with high expectations and disappointed: the global synchronised recovery turned into a global deceleration, Central Banks were tightening into weaker financial conditions, earnings expectations were too high outside the US (in retrospect), and valuations thus extended. The VIX index (an indicator of ‘fear’ sentiment) was too low. 2018 was a “give- back” year from the strong gains of 2017.
- 2019 is characterised, again, by fear and low expectations; we think markets can surprise on the upside.
While there are still risks to growth and potential for policy mishaps, it is important to note that:
- Economic growth is decelerating but unlikely to lead to an outright recession.
- Central Banks’ policies are likely to be more benign (as already witnessed by easing conditions in China and less hawkish rhetoric by the Fed).
- Oil prices have fallen, which reduces inflation risk and supports the consumer.
- Uncertainty around Brexit and US trade tensions will be resolved (at some point).
- The US Government shut-down can be regarded as short-term politics.
- Valuations are back below 30 year averages and, at 12-14 times forward earnings, are consistent with positive upside from here.
- We see little sign of accelerating inflation and bond yields have moved back lower again.
- The VIX index is currently over 20, a level which has traditionally signalled a buying opportunity.
We are not suggesting that markets will recover strongly and immediately from current levels and risks certainly remain. Rather, we believe that, at some point, conditions can stabilise resulting in returns in 2019 that can recalibrate to long-term expectations, for example 5-6% for a Balanced mandate. We believe that our active management style and strong global research can add incrementally to this level of return through security selection. We remain modestly overweight in shares, underweight in bonds and neutral in alternatives and continue to maintain a diversified approach with the following themes:
- In shares, positioning in high quality companies with resilient business models, many with good dividend yield support and attractive long-term fundamentals.
- In bonds, positioning in short dated investment grade corporate debt, high quality credit, and some Gilts.
- In alternatives, positioning in uncorrelated strategies such as gold, infrastructure and absolute return funds (depending on mandate), with an aim to mitigate some of the market volatility.
We think the biggest uncertainty this year is likely to be the relative performance of US assets and the USD versus other parts of the world. We had already reduced our exposure to the US in favour of the UK, Europe and emerging markets for a broader diversification. As active managers, if our view of the world changes, we have the flexibility to adjust weightings in client portfolios both up and down, as needed.
In summary, it is important to take a long-term view – gains over the three year period of 2017-2019 are likely to remain in line with long-term expectations. Valuations, at their current levels, provide a margin of safety for long-term investors. Although it’s always jarring to experience drawdowns to the degree witnessed in December, investors with a long-term horizon should look beyond the short-term and maintain a Strategic Asset Allocation aligned to their long-term goals.
The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation. Where links to third party websites are provided, Close Brothers Asset Management accepts no responsibility for the content of such websites nor the services, products or items offered through such websites.