Andrew Milligan, Head of Global Strategy at Aberdeen Standard Investments, discusses key lessons from a volatile year for markets and where investors could find opportunities in 2019.
2018 has been a year of change. Correlations between markets have altered, trade wars loomed and tech stocks plummeted. From political uncertainty to heighted market volatility, there’s been plenty to keep investors on their toes.
We can’t talk about 2018 without mentioning volatility – it’s been present throughout the year, more so in the spring and autumn. But we must remember that 2017 was an unusual year because market volatility was very low, so the two corrections we saw in February and October 2018 didn’t come as a great surprise.
There are a few reasons for the market volatility we’ve seen. Firstly, there’s been a steady tightening of global monetary conditions – this comes after a decade of central banks stimulating the economy, indirectly supporting bond, equity and property prices. And of course, there’s been political sensitivity on a global scale, with a whole range of issues worrying investors.
At Aberdeen Standard Investments, we suggest this volatility tells investors that they need to alter their style and approach. We think greater use of diversification where possible, such as alternative or private assets, and more stable if lower yielding assets, such as higher weightings of cash in portfolios, could balance things out. Looking ahead, we expect to see just as much volatility in 2019 as we have this year.
2018 has been an unusual year for the financial historian. We’ve seen one of the largest de-ratings of the major equity markets outside of a period of recession. Most of the major assets: bonds, equities, real estate, which would form part of a standard portfolio, have performed less well than US inflation, for the first time since the early 1990s.
Correlations between markets have also changed; bonds and equities both suffered at the same time at some points during the year, so the benefits of traditional diversification techniques aren’t as great as they have been in the past. There are several explanations for these outcomes relating either to the change of direction in global monetary policy or the sharp rise in political uncertainty.
There have been several lessons but the precise one could depend on the type of investor you are. Some would include the need for a more dynamic or tactical approach to investing, taking advantage of the sharp cycles which are being seen – putting cash to work in attractive locations.
For more patient investors, then the lesson would be to invest more in private or alternative assets in order to get some diversification benefits, but of course that means giving up some liquidity in exchange – these are by their very nature long term investments.
The $64 trillion dollar question is whether the world economy is going into recession in the foreseeable future. Our view is not, as long as politicians and central bankers avoid big mistakes.
Financial history tells us that equity markets may suffer corrections during the end stage of an investment cycle, but the pain only comes from a sharp collapse in business profits. At present there are just some amber warnings from areas such as US monetary policy, debt levels in certain countries and sectors, or the political tensions between the US and China.
At the end of the day though, it’s a value judgement just as much as hard economic analysis. But the balance of probability is that the bull run can continue as companies deliver positive profits growth in 2019. That’s why our house view remains overweight a mix of global equity markets in our client portfolios.
Some bonds are certainly back in vogue, but most are not. The answer to this question very much depends on whether you are a US or non-US investor.
A US investor has seen interest rates rising steadily, taking the benchmark bond yield to 3.25% recently. That’s quite attractive against inflation. But other countries have hardly moved on interest rates and their bond yields are generally languishing.
High quality corporate bonds have also experienced poor valuations, and high yield bonds issued by energy companies have suffered from the sharp fall in oil prices. However, we do see value in many emerging market bonds at the end of the year, and some European high yield debt too. All in all it’s a pretty complicated picture!
We’ve thought carefully about this important sector and on balance we’re bearish on many tech stocks. They were supported for many years by a combination of low taxes, low regulation and limited competition as they bought or out-stripped slower growing rivals. But now we think there are signs that some of these technology giants are becoming victims of their own success.
In a competitive market environment the super-normal profits they enjoy would normally attract the attention of rival companies. Instead, their profits are attracting the attention of regulators and governments with a growing debate about anti-trust regulation, anti-tax avoidance measures, privacy and anti-surveillance laws.
Their successful track record resulted in overly exuberant investor sentiment, crowded positioning and extended valuations – which are all changing. Therefore, we don’t expect a calm background for many of these shares during 2019.
We are indeed seeing a small Santa rally but we’re not sure how great the gift in our stocking will be come Christmas Day.
The UK stock market is, of course, being affected by the Brexit debate. But looking at global equities, we can see there’s a combination of factors encouraging investors to put their cash to work in December. The US Federal Reserve has indicated that it won’t be aggressive in its policy tightening, Presidents Trump and Xi have agreed on a ceasefire in their trade war, meanwhile the Organisation of the Petroleum Exporting Countries (OPEC) is taking steps to stabilise the oil price.
When a lot of bad news has been priced into the markets, then they’re primed for a short term rally. Looking into 2019, investors will assess whether actions from the US, China or OPEC speak louder than words; do politicians follow through with their promises?
When it comes to investment opportunities for 2019, we like several areas for different reasons. The outlook for positive company cash flow, dividend payments and share buy backs supports many global equities, especially in the emerging markets, Japan and Europe, to some extent the USA.
And in a world of low interest rates, some income opportunities could include European real estate, some developed markets such as Australian and US bonds and especially emerging market debt.
Remember though, we have cautioned about the presence of significant levels of volatility in markets, so it’s important to have diversifiers. These could include safe haven currencies such as the Yen and safer bonds such as US inflation linked debt. Or for the simple investor, a higher cash weighting could provide some counterweight in their portfolio, to put to work when attractive opportunities appear.
The information in this blog or any response to comments should not be regarded as financial advice. Please remember that the value of your client’s investment can go down as well as up and may be worth less than you paid in. The information here has been provided by Aberdeen Standard Investments and is based on their understanding in December 2018.