Headline asset class statistics for 2018 (GBP returns)
Equities: FTSE 100 -8.8%, S&P 500 +1.4%, Europe ex UK -9.2%, MSCI Emerging Markets -9.4%
Bonds: FTSE All Gilts Index: +0.6%
Currencies: GBP/USD -5.7%, GBP/EUR -1.2%, GBP/JPY -8.1%
Commodities: gold +4.4%, Bloomberg Commodity Index -5.8%
Throughout 2018 equity markets were a tug of war between buyers and sellers, and we finally witnessed a decisive heave for the sellers in the fourth quarter (Q4) that saw the S&P 500 fall by as much as 17% and caused the MSCI World Index to decline by 11.4% by quarter end. As tempting as it may be to sell due to the weak recent performance, short-term fluctuations such as these are part and parcel of investing over the long term, and selling at the wrong time often just serves to lock in losses.
Looking at quarterly returns data over the past 30 years, the global MSCI World Index has made positive returns 71% of the time, averaging 2.2% a quarter, with the worst return being minus 21.8% and the best 21.1%. The last quarter was weak (see chart below), though historically we could expect something similar every three to four years.
Source: IG, Bloomberg, January 2019
Commitment to long-term investing is neatly illustrated by the returns investors made in Fidelity’s Magellan Fund, managed by the legendary Peter Lynch. Between 1977 and 1990 he delivered annualised performance of 29%, but the average investor in the fund is thought to have made just 7% annualised by buying high and selling low. As uncomfortable as it was, staying the course proved to be the best action in the long run.
Was 2018 a particularly unusual year? It’s true that nearly all asset classes made losses (aside from gilts and gold), but in the main these losses were quite contained, and it was only during December’s equity slump after the US Federal Reserve (Fed) hiked interest rates (the ninth in this cycle), that our portfolios saw anything other than incidental declines following a very strong 2017.
Nevertheless, rate hikes, combined with a withdrawal of stimulus from other central banks, has combined to tighten financial conditions, leading to an uptick in asset price volatility. Greater volatility increases the prospects of markets making reversals, but on the upside this uncertainty has worked its way into company valuations, which are considerably lower than a year ago and offer quite an attractive starting point from which to make investments.
Smart Portfolios review
Although it was a difficult year for investments, IG’s Smart Portfolio allocations managed to avoid the worst of the market volatility with returns ranging from –0.9% to -6.6%.
A global asset allocation with substantial positions in US equities (+1.4%) provided a reasonably stable core to portfolios in an environment in which UK (-8.8%), Europe ex UK (-9.2%) and emerging market (-9.4%) equities came under pressure.
The portfolios have continued to take a cautious approach to fixed income, which saw the allocations to short-dated bonds make a cash-like return. However, credit spreads (the compensation you get from taking on company default risk) in corporate bonds widened, which caused small losses in both investment grade and high yield debt. The allocation to gold is starting to show its defensive characteristics, making a return of +4.4%.
In 2017, currency hedging was a strong positive, but this did not add any monetary value in 2018 due to sterling weakening against most global currencies. Nevertheless, it has served its purpose in reducing overall portfolio volatility and with the Brexit outcome still to be determined, we think portfolios are taking on an appropriate amount of exposure for either a ‘hard’ or ‘soft’ outcome. If the latter, or even if trade deals are struck in the event of a ‘hard’ Brexit, sterling should rally which would be favourable for our portfolios.
The latest bull market has been widely described as the most hated bull market of all time, which is, in no small part because the next recession will have been the most widely anticipated of all time.
As the cycle ages, the probability of recession rises, but there is still room for the global economy to grow in 2019, and probably 2020 too. The Fed has already scaled back its expectation of rate increases this year from three to two, and we can expect it to take further action if it sees risks in the near term.
While cognisant of the risks, this makes equities the favoured asset class for 2019. Early expectations of 15% earnings growth from US corporates might be overly ambitious, but anything approaching double figures would help to calm markets.
Warren Buffet once succinctly said, ‘price is what you pay, value is what you get’, a concept that rings truer than ever today. Your starting valuation, whether that’s buying a house, classic car, or FTSE 100 exchange traded fund (ETF) determines your future returns.
In November, BlackRock calculated that global equities were valued in the bottom quartile of their historic range (since 1995) with the US – the most expensive market – retracing from 80th to 40th percentile over 12 months. Similarly, equity dividend yields also look supportive of making gains: 5% on the FTSE 100, 4% the EuroStoxx 50 and Hang Seng, and 3% for emerging markets. These are promising starting points, with few signs right now that businesses plan to cut dividend pay outs.
There continue to be risks in making investments (Brexit and China trade tariffs, to name but two), but if some of these concerns are allayed a profitable year could lie in wait.