Predicting how markets evolve over the year ahead is a thankless task. That’s for the simple reason that it is so easy to be wrong. Even the most consistently successful investors in the world often get it wrong. However, what they do get right is realising there is a significant likelihood they won’t get all their calls right. They look at the range of alternative scenarios that might play out and invest in a way that balances their likelihood. Of course, they will weight their investments towards the scenario they believe, on balance, is the most likely and will hopefully get it right often enough to supercharge returns.
But in the long term, investing successfully is just as much, if not even more, about balancing a portfolio in a way that means its value is not devastated when markets take an unexpected turn. And that investments are solid enough that even if they take a hit as financial market cycles turn they are robust enough to be able to ride that out in enough health to be on the upwards curve when a recovery takes hold.
At the end of 2016 and early 2017, the majority of economic analysts and investment experts were worried about the beginning of the Trump presidency and had a muted, if not fearful, outlook for 2017. Of course, it turned out to be one of the best ever years for investors and equities markets across the globe as well as for many other asset classes roared in unison. It was hard to put a foot wrong and the portfolios of professional investors as well as those investing online soared. At the beginning of 2018 the inverse was the case and there was widespread optimism for the year ahead. The result was annual real losses across, according to recent Morgan Stanley research, 21 major asset classes. The 1970s was the last time that so many asset classes turned downwards in unison and many entered technical ‘correction’ territory by dropping at least 20% from their most recent high points.
At the same time, while 2018 has been a ‘bad year’ for investors, it hasn’t’ at least not yet, developed into what would be considered a market crash or schism in international financial markets. It’s hard to tell what direction things will take in the year ahead. It always is of course but there is usually some kind of majority consensus on sentiment. This time there isn’t though that might not be a bad thing for investors. Bubbles and crashes tend to unfold when there is a crowd mentality of blind positivity or negativity. Of course, uncertainty is also not a friend to investors and can be a slow, creeping disease that leads the global economy into a recession. But if the balance is right it can also act as a safety valve and healthily rebalance overheating markets.
But let’s take a look at the possible scenarios for the global and UK economies in the year ahead within the context of how they might be expected to impact upon your investments.
Investing in a Global Context – 2019
The big question for investors looking at the context of the world economy is whether the last quarter of 2018 represented a ‘correction’ for financial markets and the year ahead will represent a last hurrah for the present world economy bull cycle. Alternatively, was it the transition into a bear market for global stocks?
The yield curve inversion that U.S. treasuries are currently going through is regularly pointed to as an indicator a recession is approaching but there is a lot of debate how reliable it is. It means that long term government debt, which should offer a higher yield than short term debt of the same quality, actually offers a lower yield. It means financial markets are very nervous of the near term future, placing a premium on debt that is redeemable over the next few years.
Investors are also currently holding much more cash than at any point in living memory, which is also indicative of a fear of losing money in the short term and buy ultra-defensive equities such as utilities and healthcare stocks. The reallocation of investor cash over the past several months means that the utilities sector is trading at a higher P/E ratio than the tech sector. That’s very unusual.
However, there is also a well-supported school of thought that the current bull cycle will have one last spurt and it will kick in at some point over the first half of next year. If the U.S. economy proves more resilient than the pessimists predict and has a ‘soft landing’, which would entail continued corporate profit growth but at a slower rate than recently.
Emerging markets and China particularly are a big question around 2019 and one way or another they will be heavily influenced by dollar strength. A year ago many investors bet on the dollar staying weak and were badly burnt by its strengthening. The year before that the opposite was true. Many analysts believe emerging markets were heavily oversold last year and are set for a rebound in 2019 but that will depend a lot on whether the dollar continues to rise amid consistent Fed rate rises. If it does it may take longer for some of the areas of emerging markets that look very undervalued to make a comeback.
China and whether or not the economy that has powered the global economy for much of the last 2 decades and beyond shows evidence it can achieve a ‘soft landing’ will also be one for investors to keep an eye on. China no longer has a current account surplus and has quietly become a net borrower from the rest of the world. That’s a fact that hasn’t yet received a great deal of attention. Less than, for example, the inversion of the U.S. Treasuries yield curve. But it is likely to mean the global cost of borrowing rises over the following years with less capital available than at any point in recent history. Some analysts posit that as the most likely catalyst to the beginning of a new bear cycle.
Finally, the October 2018 downgrade of General Electric’s credit rating and the impact on the cost of the company serving its issued bond debt may prove more broadly significant than generally supposed at the time. There is a lot of corporate debt on the books of big companies at the moment, much of which paid for significant mergers. A slowing economy could well put pressure on companies and force more credit rating downgrades – another indication the cycle is turning, should it eventuate.
Investing in The UK – 2019
What about closer to home in Brexit-torn Britain? There’s a lot of talk about how cheap UK stocks look at the moment. The same was said a year ago after the FTSE 100 showed more modest returns than those of other major developed market peers as a result of Brexit uncertainty. Over 2018 the UK’s benchmark index fell a further 12% making London-listed equities look even better value. There’s a strong argument that a strong contrarian investment is to buy UK. The country’s domestic stock market currently trades at a multiple of 11 on forward earnings compared to the historical average of 14.
However, as ever, the problem is timing. A disorderly ‘no deal’ Brexit come March could well lead to UK equities becoming cheaper still. Even if a Brexit compromise is reached it looks like economic damage has already been done for both the UK and Europe. A recent Financial Time poll of 81 leading economists suggested the absolute best case scenario for 2019 is ‘uninspiring’ growth roughly equal to 2018’s 1.5%. The sentiment of the economists is perhaps best summed up by:
“Given the political shambles . . . the outlook is anything from lacklustre to catastrophic, but who knows?” said Diane Coyle, professor of public policy at Cambridge. Nina Skero, head of macroeconomics at the Centre for Economics and Business Research, said that whatever its long-term effects, “in 2019, Brexit will be either bad or awful for the UK economy”.
Of course, the revenues and profits of the FTSE 100 rely more on the global economy than local economy and further erosion of the pound’s value may well boost the index. But we’ve seen over the past couple of years that international investors can still be expected to shun the benchmark if there is negative Brexit sentiment. And the more UK-centric FTSE 250 and below would suffer more if UK economic growth is sluggish to poor.
With timing almost impossible to predict long term investors should probably forget about trying to time the bottom of the UK market entirely and drip feed any investment capital into the stock market. The same can be said for global investments. Investors targeting the return of emerging markets would be better to think long term than hope to catch the right moment, whether next year brings a rebound or a further slide into a new global or UK-centric bear market for equities.