From an investment point of view 2018 has really been an annus horribilis.  Therefore, for those of you whose portfolios are lower in value when compared with 31^stDecember 2017 you are in good company.  For those whose portfolios are higher you are also in good company!

The figures speak for themselves:

 

Equities
Region	Index	Gain/loss
UK	FTSE 100	-11.69%
US	S&P 500	-6.99%
Europe	FTSE Eurofirst 300	-13.49%
Japan	Nikkei 225	-12.64%
Asia ex Japan	MSCI Asia ex Japan	-14.02%
Emerging markets	MSCI Emerging markets	-16.90%
China	China Shanghai Composite	-23.87%
Fixed Income
		% change	31-Dec-17	31-Dec-18
UK	10yr Gilt	-3.61%	1.1910%	1.1480%
US	10yr Treasury	10.57%	2.4600%	2.7200%
Currencies
		% change	31-Dec-17	31-Dec-18
£/USD		-5.29%	1.3503	1.2789
£/€		-0.61%	1.1253	1.1185

 

I have picked these three asset classes as I believe they are the most important and their interaction is what has affected markets over the course of 2018.

Fixed income.

As I have stated in discussions on an individual basis with clients the most important influence on markets in 2018 has been interest rates.  In the US there have been interest rate rises in short term rates but more importantly we have seen large movements in the price and yield of the US 10yr Treasury bond.  This and the 10yr Gilt are benchmark bonds which give the best indication of where interest rates are headed.  Although the US 10yr Treasury rate today is 10.57% above the rate at the end of 2017 it is some way below the highs of October and November of 3.2%.  [Remember that a rise in interest rates means a fall in bond prices which means a reduction in the value of bonds/bond funds in portfolio.] The growth in the US economy is probably exhausted and we may well begin to see a recession or at least a slowdown in the economy.  The yield curve is beginning to invert which means that short term rates are higher than longer term rates.  Normally longer-term rates are higher than short-term rates.  A fall in interest rates is a consequence of slowing growth in the economy.  There is a similar phenomenon going on in the UK as 10yr Gilt yields have fallen by 3.61% over the past year.  The case of the UK is somewhat different as there is a reduction in economic activity fuelled by the uncertainty surrounding Brexit.  Businesses are not at all sure as to what they should be doing as they have no idea what the outcome of the Government’s negotiations are going to be.  The consumer also seems reluctant to spend money.  Household savings ratios have increased which will lead to recession as money is taken out of the system and not invested.  This spending reticence is reflected in the problems in the retail sector with various well-known chains going into administration.  Property prices have fallen as a result of the rise in interest rates.  Most areas of economic activity have been adversely affected by the higher interest rates.

Equities

The fall in the main stock market indices can be put down to a series of factors.  We have had a 9-year bull market and a reversal was due.  The S&P 500 hit its highest point in September but has declined ever since and is down 6.99% for the year.   Many other stock markets take their lead from the US.  The rise in long term interest rates, especially the US$ in which much of the world’s debt is denominated, has reduced share prices because of the likely effect on company profits from the rise in interest expense.  Quantative easing has been withdrawn and so the cheap money that acted as a stimulant to the stock markets is no longer available. In the UK as a result of the Brexit uncertainty many have sold their equities and are holding cash waiting for opportunities when the market is lower to buy in again.  The UK’s main index, the FTSE, is down 11.69% for the year.

Currencies

As this is written from the perspective of the UK investor our interest is the value of sterling versus particularly the US Dollar and the Euro.  The EU is our biggest export market and so the strength or weakness of sterling is critical in terms of the value of our goods in the local currency i.e. the Euro.  The lack of change in sterling’s value versus the Euro is due in large measure to the poor state of most of the European economies.   The US$ has strengthened against sterling because of the growth in the American economy. From an economic point of view sterling weakness is a good thing for exports but bad for imports, making manufacturing goods with foreign raw materials or parts expensive and consequently reducing profits.  However, from a UK investor’s point of view weak sterling is a good thing as any investment in foreign markets is enhanced by a fall in sterling’s value vis-à-vis the currency of the investment.   From this you can see that a well-diversified portfolio including currency diversification, which every investor should have, is beneficial.

What then is the outlook for 2019 and what should one do, if anything?

Until the Brexit issue is resolved the UK stock market is likely to be in a state of flux.  Once there is clarity on this, it will settle down and there will be less volatility.  It is unlikely that interest rates will rise given the weak condition of the economy. Investors will probably return to the equity markets but cautiously.  If dividend yields stay at their current high levels of about 4% for most FTSE 100 companies (over 30% have a yield in excess of 5%) then people will be happy putting their money into the stock market for the yield with less concern for the risk. As far as the US equity market is concerned, many commentators believe that the S&P 500 will not rise above 3000 (currently 2506).  Thus, no great gains there and other equity markets will probably follow.  Unknowns are the following: in the US the trade war with China and in Europe the Italian debt problem.  Neither issue helps their respective market.

 

Investing for the long term is critical.  It is not a good idea for the retail investor to be trying to outwit the market.  He almost always fails because by the time he decides what to do the rest of the market has done it.  It is a case therefore of finding good fund managers who have a long-term view, do thorough research and are prepared to stick with their allocations.  It has been shown consistently that this modus operandi produces the best results.

 

RF