By Hottinger Investment Management
The calendar year 2018 was a difficult year for investors – particularly multi-asset investors – due to the number of different asset classes offering a negative real return. This was particularly true for US equity markets, especially following the anxiety exhibited in December. Markets had to come to terms with the prospect of a significant slowing in earnings growth in the 4th quarter of 2018; the US fiscal tailwind has weakened and some direct talking by Federal Reserve Governor Powell has caused a reassessment of the global outlook. The December sell-off currently appears to be a snap reaction to the belief that Fed tightening is now ahead of the curve, however if an economic downturn does arrive in 2019 it may start to look justified.
The S&P 500 suffered the worst December contraction in its history, falling by 9.18% and taking US equities into negative territory for the year (-6.24%) as investors lost their nerve. Notably, the weakness in global banks that has seen many European and Chinese banks fall into bear market territory this year (down 20% from their previous peak) has spread more widely in the US. This left the S&P Banks Index down 14.88% in December and down 18.37% overall in 2018.
Banks are seen as the most influential value sector and the performance of the sector has masked any rotation away from cyclical stocks. The final quarter of 2018 saw a more traditional flight to quality, for example in utilities, despite the prospect of rising interest rates. Our caution as we entered the summer trading months was triggered by high valuations and narrow dispersion of positive returns, which was highlighted by the performance of consumer technology as represented by the FAANG Index. Interestingly, the index rallied 36.83% to its year high on June 20 before returning -36.75% into year-end, but was still narrowly net positive (0.08%) for the full year!
US Treasuries were up 2.29% on the month and physical gold rallied 4.90%, although the latter still failed to offer a real return over 2018 (falling 1.58% as the metal struggles to break through $1,300/oz). Despite the yield on the 10-year US Treasury reaching 3.25% in October – when the outlook for US rates was deemed too aggressive – this has quickly rallied to 2.65% as US equities have suffered. At inflection points, it is often the case that previously uncorrelated assets move together through short-term stress, (as seen in February and October) so the resumption of a traditional relationship between US bonds and equities is encouraging.
UK equities may look relatively cheap on a global basis, but they remain unloved and under-owned. The lack of a consensus in Parliament led to Prime Minister May postponing the crucial vote on the deal negotiated with the EU, and it now looks as if negotiations are going to go down to the wire. The increased probability of a “no-deal” Brexit – which would be very harmful to the UK economy, at least in the medium term – pushed sterling another 0.70% weaker over the month and the FTSE All-share down 3.88%,. This also impacted EU economies already struggling with a China slowdown and US protectionism, reflected in the fact that European equities lost a further 5.96% on the month. The ECB’s decision no longer to expand QE has added to the global tightening bias, removing significant global liquidity and adding domestic financial pressure to the geo-political pressure suppressing European growth.
Looking forward, it is likely that 2019 will see slowing earnings, slowing growth and continuing high levels of central bank and government influence over financial markets. This leaves investors vulnerable to higher volatility in distressed conditions, and a cautious approach may be necessary if we are to preserve capital in the medium term.
Our investment strategy committee, which consists of seasoned strategists and investment managers, meets regularly to review asset allocation, geographical spread, sector preferences and key global market drivers and our economist produces research and views on global economies which complement this process.
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