Market volatility picked up markedly in 2018 as global growth slowed, US interest rates rose and geopolitical stress intensified. Investing is about deciding which risks are really opportunities and which are best neutralised. While the current economic expansion is increasingly mature, further stimulus is in the pipeline and we have a high level of conviction that stock markets will make further gains in 2019. The Brexit process, on the other hand is inherently unpredictable with a wide range of possible outcomes. From an investment point of view, Brexit is about risk control.
The US economy is enjoying one of its longest economic upturns in history. It has been almost nine and a half years since the financial crisis recession ended. Looking at records since 1857, only the 1990s expansion was longer and that by just six months. Economic expansions don’t necessarily die of old age but this one is getting a bit long in the tooth. Unemployment rates are very low, wage rises are gathering pace and Federal Reserve interest rate hikes are starting to have a negative effect on the US housing market. Against this backdrop, with Chinese growth slowing and trade war fears at the fore, we’re not surprised stock markets suffered a seasonal sell off in the autumn.
There are reasons for optimism for 2019. Investor sentiment has been severely dented and this often sets the scene for better returns as financial market stress tends to trigger action from policy makers to boost the world economy. To this end we have seen China announce a new stimulus package, the US Federal Reserve has indicated that interest rates aren’t far from where they should be and President Trump has cancelled a planned tariff increase to 25% on a wide range of Chinese imports. In addition, we have seen a sharp supply-driven drop in the oil price which should take the sting out of inflation and act as a tax cut for the global consumer.
Stock markets tend to make little progress over the summer and they usually post almost all of their returns in the fourth quarter and first quarter of the calendar year. If we’re right, China will pick up while the US economy is still benefitting from tax cuts and spending increases. An upturn in profits should boost stock prices. We’d also expect to see further interest rises in this scenario, however, raising the risk of weaker growth, perhaps even a recession, heading into 2020. More volatility is likely.
Brexit is a known unknown. It’s a fast moving situation but one thing is clear. Almost anything can happen. It’s possible the UK leaves the European Union without a deal. A cliff edge, disruptive Brexit would damage the economy and we’d expect the pound to drop sharply. Alternatively, the UK could yet remain in the EU on current terms. In this scenario the pound would rise sharply. Deciding which is going to happen isn’t easy. Any political deal would go to the wire. A referendum on the final deal would be closely fought.
Rather than trying to predict the outcome, we prefer to neutralise risks where possible. Our portfolios for investors with a low appetite for risk have a high proportion of their assets invested in sterling-denominated fixed income and cash, so these investors need not worry too much about swings in the exchange rate. Portfolios at the higher end of the risk spectrum balance equity exposure with commercial property. We’d expect equities to do best in a no deal outcome with a weak pound, as the lion’s share of corporate earnings comes from overseas. Property is a domestic asset class and would do better in an outcome closer to EU membership.
Whatever the future brings, one thing is certain. Spreading investments across a broad range of asset classes in proportions tailored to individual risk profiles makes a lot of sense. If markets do take a turn for the worse, having an active strategy that can change with the times will be more important than ever.
Head of Multi Asset at Royal London Asset Management
Trevor Greetham is a portfolio manager at Royal London Asset Management. Prior to joining Royal London in 2015, Trevor was asset allocation director for Fidelity Worldwide Investment, where he was responsible for implementing tactical investment decisions across a wide range of institutional and retail funds including the Fidelity Multi Asset Strategic Fund.