Looking ahead – what’s in store for investors in 2019?
Higher volatility and a preference towards healthcare investing.
- 2019 will see higher levels of volatility than recent times, resulting in lower levels of returns.
- Our preference will be for more active alpha-generating strategies over passive structures.
- Healthcare was identified as a preferred sector for 2018, and will be in 2019.
Looking ahead we remain firmly in the belief that 2019 will bring even higher levels of volatility than investors have got used to in recent times, resulting in lower levels of returns. This is a consequence of a confused outlook dogged by trade tensions, monetary conditions, corporate earnings expectations, political posturing, inflation and pressure from governments on central bankers to keep condition loose.
Such conditions justify our view that diversification will help to mitigate these scenarios as much as possible. It’s worth noting, we remain unconvinced the US will enter into recession in 2019.
Unsurprisingly Brexit rhetoric will persist. From an investment perspective though, sentiment is likely to remain challenged and, certainly in the near term, be a bumpy drag on valuations. Whether there is a deal or not, it is likely the country will know the type of Brexit we are likely to get before we finally leave in March. This should give time for measures to be enacted to help mitigate a full blown crisis.
The UK currently trades on an unchallenging cyclically adjusted PE and while there is risk to the downside, the upside looks increasingly like a risk that’s worth taking, certainly over the longer-term. The greater risk to UK valuations in 2019 is aligned more to the prospect of a General Election.
With an absence of recession warning lights, the consensus seems to be for the US to avoid one in 2019, albeit with the yield curve inverting recently – investors are taking more notice. The inversion of the US yield curve has been a very consistent predictor of US recessions, albeit most commence some six to 24 months after.
There is some anticipation that weaker growth, higher inflation and liquidity conditions getting tighter are causing headwinds to build. However, food price inflation has been getting softer recently, falling back to a two-year low, the oil price has slipped from c.$85 a barrel to c.$60 and real wage growth has been rising. This could support consumer spending power through 2019 and therefore we wouldn’t rule out the US bucking the slowing trend.
The transitory effects of low world food and fuel prices could see a possible plunge in US inflation which will likely put pressure on the US dollar and raise uncertainty around the 2019 interest rate rise path. Additionally, the US fiscal stimulus is set to fade and the much talked about cut to middle income earners tax at the mid-terms is unlikely to get any traction with the Democrats taking the House.
As you can see from our thinking, the outlook for the US is somewhat confused in 2019. For now we are reluctant to cut our US positions, particular in sectors where we continue to see good opportunities. Albeit our view on prevailing market conditions is reviewed regularly.
Having avoided investing in China for a while, valuations are now looking more attractive which is causing us to spend more time looking at possible opportunities in the region. Even though this is the case we remain unlikely to rush to build a position in the region in 2019. The trade dispute with the US looks more tenuous, despite there being a 90 day breathing space before additional tariffs are deployed. Even though it may have been an unintended consequence, the US seeking the extradition of the Huawei CFO in Canada, adds another dimension to the dispute. Growth in the region has continued to show signs of slowing and stimulus measures are having only a marginal impact.
European economic momentum has slowed down in 2018 as global trade concerns have become more prominent, coupled with a more challenging backdrop in Italian politics. We anticipate growth will continue to slow through 2019 yet, despite this, the regional outlook is still reasonably bright, wage pressures are starting to build and recently corporate earnings have been supportive.
The outlook for emerging market assets is looking challenging. Dollar strength will only act as a headwind to capital flows to emerging markets that are reliant on foreign investment. It can also make the servicing of dollar-denominated debt more challenging. Over the long-term we are of the view emerging markets will likely outperform developed markets and valuations are more attractive now.
Commodities tend to perform better and normally benefit in the latter part of the economic cycle. However, slower global growth and lower demand from China are likely to dampen performance this time round.
Oil oversupply has been the popular reasoning for a fall in the price in Q4 2018, yet we have some concern this may actually be a reflection of slowing global growth. Only time is going to tell.
Gold tends to perform fairly poorly in a rising rate environment but does well in periods of slow growth, rising uncertainty or a weakening US dollar environment. In the near-term most indicators are pointing to global growth slowing and question marks now hang over how much the FED will tighten rates in 2019, as concerns of an inverting yield curve come more to the fore. The US dollar has been on a tear, but we are doubtful about rate increases and believe the challenge of financing the US deficit will weigh on sentiment later in the year, which could benefit holders of the shiny metal. Additionally, China is likely to be a structural buyer of gold over the long-term as it seeks to become less reliant on dollars.
Our biggest concern looking ahead is for a policy misstep by the FED, which would adversely affect the growth outlook. Should a slowdown or the building of recessionary pressures in late 2019 emerge the US and China look better placed to deploy monetary and fiscal measures to support their economies. That could be more challenging for others.
Assets we like
Volatility looks likely to persist in 2019 as a consequence of tighter monetary conditions and by our way of thinking, owning a diverse base of assets that lack correlation should help dampen the impact.
We continue to favour equities over bonds generally but where we are required to have exposure to bonds we have favoured a combination of fixed and floating rate bonds, securitised investments such as Mortgage Backed Securities (MBS) or US Treasuries. While we think earnings will continue to be supportive, we also think adjustments to expectations will be impacted by servicing debt obligations. For this reason, and where possible, we are consciously adopting a quality bias in our portfolios. We are being more selective with our equity positions, while also taking an interest in unlisted equities and building a position in gold.
Our preference more generally will be for more active alpha-generating strategies over passive structures.
The global picture
Brazil’s record low interest rates and benign inflation in 2018 helped corporate results. With consumer sentiment in the region topping expectations, ongoing economic recovery and attractive valuations, the region continues to remain appealing.
Japan’s central bank remains accommodative and valuations continue to trade at a relative discount to developed market peers. Moreover, it should be a beneficiary of domestic growth picking up as global trade frictions abate.
India continues to grab our attention as inflation has been brought under control from previously high levels, which should be sustained by the central bank inflation targeting. Now looks like an opportune entry point as valuations are trading significantly below the region’s historic premium and sentiment is bearish. Earnings growth is on par with Brazilian estimates in the region of 20% growth. An April election is likely to be a near-term headwind. Whatever the outcome, over the longer-term we anticipate the government of the day continuing to pursue structural reforms in the quest for sustainable growth for India.
Sectors we favour
Despite challenges to tech valuations in 2018 after a number of years delivering some eye-watering returns, we continue to see opportunities. Broadly speaking we continue to see long-term value in technology companies across market caps, but we try and look beyond the confines of technology sector definitions. And when identifying these opportunities we look for managers that utilise technology, seek companies that utilise technology, or rely heavily on it, or where technology is the primary revenue source of the company they are investing in.
Infrastructure typically has stable, defensive and inflation-protected cash flows and capital growth opportunities. Therefore exposure to infrastructure is important going forward as headwinds to growth pick up. Sector valuations look appealing, providing a good entry point.
Healthcare was one of our preferred sectors of 2018, and it hasn’t disappointed, meaning it remains a preferred choice in 2019; albeit the valuation has become more challenging. In periods of uncertainty investors have, on a relative basis, fared better in healthcare and consumer staple stocks. Our preference for healthcare is down to the balance sheets of healthcare companies, which remain solid and flush with cash. They offer attractive dividend yields and there is an increasing possibility of more share price enhancing buy-backs.
We continue to expect returns from equities to moderate ahead . We maintain a preference for equity investing over fixed income and encourage investors to have some exposure to gold, as a diversifier at this point in the cycle. Where investors need some exposure to fixed income in their portfolios we believe they should be shortening their duration exposure and increasing the credit quality.
Inflation in developed economies is expected to trend around 2%, interest rates are expected to continue to rise in the US and global economic growth is expected to slow with the potential for trade tensions to put a sharp break on that.
As highlighted we have become more contrarian on the UK and we continue to have a positive long-term regional bias for Japanese, Brazilian and Indian equities. While we are more cautious on the US and China, we believe investors should not be too light in their US exposure as we continue to see opportunities in technology, healthcare and infrastructure given they are all sectors in which the US dominates.
One thing we are certain of, investors are going to have to get used to lower rates of return and higher levels of volatility.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.