Risks and opportunities in 2019

18 January 2019

By Sheldon MacDonald, co-fund manager HC Verbatim Multi-Index Funds

What happened in 2018?

2018 was a challenging year for investors as volatility, the rate of change of asset prices up or down, returned with a bang. Markets suffered their biggest overall losses since the 2008 financial crisis with nowhere to hide across asset classes as global bonds provided scant protection from sharp declines in equity markets around the globe.

After notching up the longest bull market in history, stock markets finally succumbed to concerns over trade war uncertainties and signs of a global economic slowdown. A strong dollar and worries about corporate earnings in particular in the tech sector also weighed on markets.

Meanwhile, although bond markets were boosted towards the end of the year by the weaker economic outlook, they were affected early on by interest rate hikes in the US necessitated by the threat of rising inflation. In addition, there was growing uneasiness over the scale of debt taken on by companies. The challenges for investors didn’t stop with stocks and bonds; gold and oil were also among the assets down in 2018.

Outlook

In 2019 the overall investment environment remains complex and we are conscious that many of the risks that hurt markets last year are still in the picture for 2019. Last year as global growth slowed, the world’s major central banks continued to reduce their monetary policy accommodation in an attempt to bring the financial system back to more normal levels.

This added enormous pressure on global equity markets and the already flagging corporate bond markets. However, as we have seen significant dips in assets prices, especially in the latter part of the last year, valuations are certainly now more attractive, which could offer some opportunities.

Top potential risks and opportunities

Risks - top three risks we have identified for markets:

  1. If the US Federal Reserve continues to raise rates to a level that is too high to be sustained by a slowing economy then it could increase the risk of a slowdown or even a recession in the US which could quickly spread to the global economy.
  2. Geopolitics caused significant disruption to markets in 2018. Although there are fewer market-moving political events on the calendar for 2019, we still believe the remnants of recent political events such as the US-China trade war, Brexit and Trump related incidents could continue to influence market sentiment and therefore volatility.
  3. The level of debt on company balance sheets relative to their earnings is hovering at pre-financial crisis highs. There is a worry that that as interest rates rise weaker companies with substantial debt loads could find it tougher to make payments on loans. This puts pressure on corporate bond markets leading to lower valuations for investors.

Opportunities - three asset classes we currently favour:

  1. Last year we saw traditional financial markets, like equities and bonds, become more volatile after several years of calm. Adding real assets or specialist property to a portfolio can be a good diversifier, as it can be helpful to have exposure to assets which tend not to behave in the same way as traditional asset classes.
  2. If some of the potential risks for 2019 do not materialise, there could be a number of buying opportunities. We believe that emerging market equities in particular - from a valuation perspective - would benefit relative to developed market equities in the event of an easing in US-China trade tensions. Also, we expect the economic growth of emerging markets to outstrip their developed market counterparts. Another potential buying opportunity, if risks dissipate, could be European equities. The settlement of Italy's budget row with Brussels helped investor sentiment and the possibility of trade tensions easing could provide a boost to Europe, a region that is highly leveraged to global growth due to its significant exporting industry.
  3. If the outcome is negative on these risks, there may not be many places to hide. With a global downturn potentially on the cards, even though they are currently expensive government bonds could provide a counterbalance to riskier assets like equities that would be likely to provide negative returns.

What does this mean for investors?

Markets are unpredictable and it will always be difficult to foresee what will happen in the future but we believe the bumpy ride is likely to persist over the coming months. So to help our portfolios weather the market conditions, we will continue to advocate the principles of diversification across asset classes, currencies, regions and investment managers.

It may be wise not to take a short-term outlook, and avoid overreacting to immediate stock market moves. Right now, investors can see that markets are struggling, but most believe that given time they will bounce back. In fact, many see this as a buying opportunity. 

We believe that diversification can help to smooth out the returns. A well-constructed portfolio, designed around your time frame and keeping your portfolio diversified could be a prudent way to weather the current uncertainty.

The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.