Global Market Overview
Any hopes of a so-called Santa rally were short-lived in December with all major markets posting losses for the month. Despite November’s brief respite, the fourth quarter turned out to be the worst in the last seven years. Investors have lost confidence against a backdrop of rising US central bank interest rates, a sharp slowdown in Eurozone business confidence, weaker Chinese growth and the prospect of global trade wars. The MSCI World index fell 7.44%, the biggest December decline since 1970. The weakest region in sterling terms was the US where the S&P 500 declined 8.91%. This is the worst monthly performance for the US stock market in nearly eighty years. Japan’s TOPIX index posted a decline of 7.12% in sterling terms. In local currency terms the market fell 10.21% but a 3.68% rise in the yen helped to cushion the fall for UK investors. Conversely for a risk-off environment, Emerging Markets fared reasonably well, falling by a more modest 2.48% in December with the result that the MSCI Emerging Markets index outperformed the MSCI World index by a considerable margin over the quarter with a decline of 5.14% v 11.35%.
Even though US GDP growth is positive and is forecast to remain so in 2019, investors are concerned about the likely path of interest rates and the extent to which the Federal Reserve will continue to tighten policy. As we noted last month, the Fed’s Chairman, Jerome Powell provided a boost towards the end of November when he said that rates were “just below” the range estimates for neutral. However, at the December meeting when the Fed lowered its guidance from three to two rate hikes next year this was regarded as less dovish than the market had been expecting. Investors are also starting to worry about the fading effects of the fiscal stimulus from Trump’s tax cuts which following the Democrats’ success in winning the House are unlikely to be extended. On the positive side, inflation and labour costs are only rising gradually.
In Europe, the picture is less rosy with business surveys continuing to decline and with manufacturing surveys at levels consistent with a contraction rather than just a slowdown. This has been attributed to a slowdown in demand from China but also domestic political factors, particularly in Italy and France. President Macron has reacted to the protests about high fuel costs with cuts to fuel duty and a range of other stimulus measures. Despite these issues the European Central Bank ended its quantitative easing programme in December, as expected. Earnings results have been disappointing in 2018 but forward growth expectations remain positive.
The UK economy has softened after a strong summer and Brexit uncertainty continues to dominate. Despite accelerating wage growth, business and consumer confidence and the house market have been impacted by the ongoing Brexit machinations. The Bank of England kept rates at 0.75% in December.
Japan’s economy continues to slow and the Bank of Japan is maintaining it’s highly accommodative stance. Despite this, the Yen has rallied relative to other currencies. This is consistent with the rise in risk aversion and perhaps indicative of investor’s views that the US rate cycle may be peaking.
Trade tensions continue to be the major factor affecting investor sentiment in Asia and Emerging Markets. Chinese imports have slowed from 37% year-on-year growth in January to 3% in November 2018. Retail sales growth and industrial production have also slowed. In response, China has initiated a series of monetary and fiscal measures designed to stimulate the economy. In India the governor of the Reserve Bank of India unexpectedly resigned from his position in mid-December, citing personal reasons though it is thought that he did not agree with the government on policy. The new incumbent is a retired civil servant who has previously worked closely with the bank and government.
UK government bonds had a positive month with the FTSE Actuaries UK Conventional Gilts All Stocks index advancing 2.19%. Corporate bonds as represented by the ICE BofA Sterling Corporate index also rose 1.14% but underperformed gilts. For the year UK government bonds managed to eke out a positive return but it is notable that in the US both equities and bonds underperformed cash. This is only the third year since 1900 when this has occurred.
The oil price continued to decline over December (-8.64%), bringing the quarterly decline to 32.38% as rising supply, led by US shale production, caught up with demand and fears for the global growth outlook weighed on sentiment.
Performance of RPW Models over one month to 31st December 2018
All RPW models declined over the month. The RPW Cautious Model held up reasonably well declining by 0.58% but the RPW Adventurous Model suffered a fairly significant fall of 6.56%.
Performance of RPW Models Year to Date, to 31st December 2018
The torrid fourth quarter means that all RPW Models are now in negative territory over the course of one year.
Five Year Performance of RPW Models since inception in January 2014
In the five years since inception in January 2014 up until 31st December 2018, the Cautious model has delivered a return of 18.3% (not including fees). This compares to a return of the ARC Sterling Cautious Index of 11.69%. Over the same period the RPW Adventurous Model has returned 52.3% (not including fees). This compares to the ARC Sterling Equity Risk Index return of 26.59%.
(Source: Financial Express Analytics, Total return, Gross of fees, as at 31st December 2018).
Please note that these figures are unaudited and indicative. The performance of actual client portfolios may be different. The effect of fees will reduce the returns achieved.
There was a wide dispersion in fund performance with Allianz Gilt Yield, demonstrating its traditional function as a portfolio diversifier, achieving a return of 2.57%. Apart from Allianz Gilt Yield, which invests in UK government bonds (gilts), the only other funds which were positive were the fixed interest and cash funds. The M&G Corporate Bond invests in investment grade corporate bonds and also has quite a high duration (sensitivity to interest rates) which means that it tends to be more defensive when growth is thought to be faltering and the prospect of higher interest rates is therefore deemed less likely.
The worst performing fund was Legg Mason Japan Equity losing 11.71%. Legg Mason Japan Equity had been the best performing fund in November; it tends to outperform when markets rise and underperform when markets reverse. Other than Legg Mason, the other funds at the bottom of the table were all ones which invest in the US, Merian North American Equity (-8.5%, Jupiter North American Income -9.11% and &G US Index Trust -9.25%). The manager of the Jupiter North American Income fund has recently changed following a strategic review. We will be meeting the new manager next month to assess his approach and the prospects for the fund.
After nine years of growth and as higher interest rates start to bite in the US it is perhaps not surprising that equity markets in 2018 experienced a setback.
In the UK, the situation has been exacerbated by concerns surrounding Brexit. The UK was one of the worst performing major stock markets in 2018 with the more domestically oriented FTSE 250 falling 15.15%. The All Share did better returning -9.47%. Other markets fared worse in local currency terms but outperformed once sterling’s weakness is taken into account. The bottom line is that UK investors were better off if they invested overseas. Our base case remains that the UK will not end up crashing out of the European Union on 29th March but we acknowledge that the risks of it doing so have increased. The market remains completely unloved and cheap on many metrics and will likely bounce if a deal is achieved but with the potential outcomes so binary it does not seem prudent to us to change our allocations to the UK.
Whilst Brexit is dominating the thoughts of those of us in the UK, the global investment community is more preoccupied with the deceleration in global growth, particularly in the US and China. Is the decline in global stock markets a healthy correction or the start of something more insidious? At the time of writing, markets have recovered some of the lost ground, with markets interpreting the Fed Chairman Jerome Powell’s most recent remarks as an attempt to dial back on his more hawkish commentary in December. There are some striking parallels with early 2016, a year in which all major equity markets generated double digit returns. Then as now markets had experienced a significant sell-off in December and the Fed had raised rates but then backtracked. Similarly, the Chinese economy was slowing, and the authorities put in place measures to stimulate it, as they are doing again now. We don’t yet know if they will be successful but, as we have repeatedly stated, we do not recommend to clients that they try to time the markets but that they stay calm and remember that being invested over the longer term is the best way to accrue returns.
One positive feature of the market declines is that valuations are more attractive than they were. The market ended 2018 still facing the same risks to which much of the sell-off can be attributed, trade wars, slowing growth, Fed rate hikes and political tensions, but valuations in the US are now at levels last seen nearly five years ago.
Whilst this provides some comfort investors should prepare themselves for a continuation of the levels of volatility that we saw in 2018 rather than a return to the extraordinarily low levels prior to that. With quantitative easing having provided a boost to valuations it is high likely that quantitative tightening will mean that even if the bull market remains intact, future returns are likely to be more muted.
One final point, the US stock market notably underperformed the rest of the world in December. However, this has done little to dent the outperformance over the past decade. This suggests that there may be further to go if investors rotate away from the US and into areas perceived as offering better value. One such area is Emerging Markets. As noted in the opening paragraph, Emerging Markets outperformed their developed market counterparts in the fourth quarter. This relative outperformance in a falling market is unusual. Normally the greater risks associated with less developed economies means investors tend to sell when investor sentiment is negative. However, if investors are expressing concern that relative valuations in the US are still too high then this relative outperformance could be set to continue.
Investors should continue to maintain diversified portfolios and for those with anything but an aggressive attitude to risk, ensure that they have a blend of defensive and more risky investments. A disciplined approach to asset allocation and identifying good active managers who can navigate these conditions successfully remains of the utmost importance.