Richard Flax, Chief Investment Officer, Moneyfarm
This year has been one of global boundary pushing, as political leaders, negotiators and Central Banks try to navigate their way through an uncertain world.
As a result, Brexit negotiations have been fraught, monetary policy ambitious, and trade tensions have increased.
A lot has happened this year, too much to write in one blog that will keep your attention to the end. Instead, below are the biggest themes of 2018 the Investment Team and I have been monitoring when managing your portfolios.
The return of volatility
2018 was the year volatility returned to the markets, breaking the calm waters of 2017 and catching many investors by surprise.
I can’t stress the following statement enough – volatility is a normal feature of the financial markets. However, understanding the concept doesn’t make the impact on your portfolio any more comfortable.
This is why it’s so important to reflect your investor profile through your portfolio and to have as long an investment horizon as possible. As uncomfortable as volatility is in the short-term, it’s time in the market, not timing, that helps maximise returns over the long run.
Read more about how to invest through uncertainty.
Monetary policy
Monetary policy certainly stole the show in 2018. In the US, the Federal Reserve (Fed) continued its programme of normalising monetary policy – hiking interest rates in-line with market expectations but against loud protests from the White House.
Markets have become nervous as the Fed has seemed ambivalent to the impact higher interest rates would have on economic growth, exacerbating volatility on the equity markets.
The Central Bank hiked interest rates four times in 2018, as expected. Although it now expects to increase interest rates less in 2019 than it previously had planned, the rhetoric wasn’t cautious enough for concerned markets.
In the US, growth is robust, unemployment is down to levels not seen since 1969 and wage growth is picking up. Yet inflation expectations have been weighed down by the oil price slump and the Fed’s tightening balance sheet is causing problems for emerging markets, equities and credit.
Elsewhere, interest rates were hiked once in the UK to 0.75%. The Bank of England is carefully managing its programme over Brexit uncertainty, to ensure monetary policy doesn’t put pressure on growth during a time of such political uncertainty.
US
In a year of largely negative returns, US equities outperformed most global equity markets in 2018. Although the year started well for the S&P 500, increased tensions saw the index drop around 3% this year, compared to an 11% fall in European index, Euro Stoxx.
Robust economic growth and strong corporate profitability, aided by Trump’s tax reforms, helped support US equity returns. But the US wasn’t immune to short-term fluctuations in 2018. The US government seemed to replicate a game of musical chairs in terms of appointments, with some now being accused of breaking the law.
The tech sector also stole headlines in 2018. Facebook was the first casualty, following its Cambridge Analytica scandal, which saw concerns over regulation and the future of the wider tech industry questioned by markets. Facebook stock has fallen by as much as 40% from its peak in July.
The market largely ignored the geopolitical noise of trade bickering between China and the United States last year, however investors started to listen in 2018.
The tech industry wasn’t immune to trade war tensions, with Huawei’s CFO being arrested by the Canadian government, at the request of the US, for allegedly breaching US sanctions against Iran. Tech manufacturer Lenovo was also accused of putting chips in computers to spy on US companies and government agencies.
Another potential tech trade war victim was found in Apple, which had become the first trillion dollar company in mid-2018, before indications that China would restrict access to core Apple systems and products weighed on its valuation. Apple has since fallen 28% since October, although wider global market risks have been priced in.
The yield curve
The US yield curve came back into focus this year, as the spread between 10 and two year yields tightened, with the 10 year yield only about 10 basis points above the two year.
The US government borrows money over several different time periods, predominantly one year, two years, five years, 10 years and 30 years. Each of these time horizons will have different rates attached to them. Input these different rates into a chart and you get the yield curve.
Treasury bond yields say something about where the market expects future interest rates will be, and we believe the curve reflects expectations that US growth and inflation probably won’t accelerate in the short-term. And maybe that’s not so bad – after all the US economy is growing quite nicely, and generating jobs and wage growth.
It is worth pointing out, though, that the US yield curve has been relatively flat for several years now, even as economic growth has been decent. This could reflect demand for long-dated government bonds from pension funds or the impact of quantitative easing on the bond market. Whatever the reason, a flat curve hasn’t signalled slower growth so far in this economic cycle.
Read more about the yield curve.
UK
As the clock counts down to 29 March 2019, the day the UK is set to leave the EU, keeping up with the progress of Brexit gets more and more difficult.
The story changes by the hour: whether it’s the date of the Parliament vote, Theresa May’s attempted No Confidence coup, the details of her deal, or the opposition’s response to it.
The uncertainty is very difficult for financial markets to price in.
Following the Prime Minister’s vote of confidence, May went to try and renegotiate the Northern Ireland backstop, and seek assurances that any adoption of EU customs union rules in the event of no agreement on the hard border would be temporary. European leaders pushed back, however, and the growing consensus is that the Prime Minister’s Brexit deal won’t be approved in mid-January.
Ministers are now publicly calling for alternative outcomes, whether these are a managed No Deal, a second referendum, or a Norway Plus arrangement.
If Theresa May gets to a Parliament vote and this is turned down, we see the following as reasonable scenarios to expect.
- Politicians get nervous and they pass the bill in the second attempt to avoid to unknown
- Some of the amendments allow Parliament to take control of the process, which could prompt a vote on a second referendum
- Labour brings a vote of no confidence to the government, which the government lose and we have a general election early in 2019.
Despite the political uncertainty of Brexit, UK markets have remained fairly calm. Sterling has weakened only slightly since its initial post referendum devaluation, although positive momentum from 2017 has been unwound this year. UK equities have underperformed the global benchmark by a couple of percentage points. Where you can see nerves really spill over into the markets is with UK future inflation rates, reflecting Increased concern about inflationary risks.
Read more about how Moneyfarm portfolios are prepared for Brexit.
Europe
All eyes were on Europe at the beginning of 2018, and most were wearing rose tinted glasses following a surprisingly strong 2017. The tint quickly seemed to fade away, however, at signs of strain on the continent.
European growth started to stall, particularly in Italy and Germany. Politically, it’s been another tough year for the eurozone, with the new Italian government struggling to get its Budget approved by the EU, and the business disruption caused by protests in France helping accelerate already deteriorating economic growth across the eurozone.
The euro weakened against the dollar and bond yields edged lower. With earnings expectations being steadily downgraded, equity valuations unwound back to the 10 year average after trading above this level.
Emerging markets
Overall, emerging markets have disappointed this year, as lower earnings expectations have impacted the asset class. Now, on traditional valuation metrics, emerging markets show better value for long-term investment horizons than most other equity markets.
From a financial market perspective, the relationship between exports and Emerging Markets earnings looks pretty tight, so trade tensions are a big theme here.
When we think about the risks of a trade war – it’s clear that earnings could be at risk. Overall, we’d argue that growing trade is generally positively correlated with global growth, which should be supportive for earnings, notably in Emerging Markets.
We’d argue that trade wars matter for global growth – and there are clear knock-on effects for risky assets like equities. In particular, it seems that Emerging Markets earnings could be at risk in a world where the growth in global trade slows.
Cryptocurrency
This time last year, we were inundated with requests from customers wanting us to add cryptocurrency to our portfolios. Looking at the success of bitcoin in 2017 it’s easy to see why investors across the globe were interested, it seemed like an easy way to make money.
We didn’t view cryptocurrency as a suitable asset for our investment portfolios, given their risk levels and our Investment Strategy. We still don’t.
The risk you have to take to make an easy buck means it’s also incredibly easy to lose it too – and wildly unpredictable. Taking bitcoin as an example, the cryptocurrency has fallen from around $14,000 on 25 December last year to under $3,500 today.
If you enjoy the buzz of trading in the cryptocurrency market, we suggest you do so with the money you’re happy to lose. When growing your money for your long-term financial goals, whether that’s a holiday home, supporting your children, launching a new business, or simply financial security through retirement, we’d argue that a long-term diversified investment portfolio designed for your risk profile continues to be the best strategy.
Read what we said at the time about cryptocurrency.
If you have any questions about the Investment Strategy or what your Investment Team have been thinking about when managing your portfolios, please get in touch with our Investment Consultants, who would be happy to answer any questions you have.
