THE year 2018 turned out to be an "annus horribilis" and portfolio managers must be scratching their heads about what to do in 2019. It's difficult to find asset classes that delivered positive returns in 2018, as across geographies and asset classes, markets were in dire straits. Equity and fixed income indices were negative for the year and commodities showed a mixed picture.
The question now is, did the financial markets' poor performance reflect an equally suffering global economy? In short, the answer is no. Looking at various factors, we are left with the two usual suspects likely to be responsible for last year's poor performance: higher short term USD rates and the markets' assumed ability to anticipate serious issues. We doubt especially the validity of the second reason, as neither the European uncertainties (the Italian budget and Brexit negotiations) nor the rise in protectionism should be able to derail the global economy in 2019. Therefore, if our diagnosis is correct, we think it is too early to move away from risky assets.
The Global Economic Policy Uncertainty Index is at one of its highest readings ever, indicating that financial markets and its participants have significant difficulty in foreseeing and understanding how economic policy will evolve at this stage. If there's one thing that markets don't like, it's uncertainty. This explains to a certain extent why markets were so negative and volatile at the end of 2018.
So with a difficult year behind us and uncertainty at all-time high, what should investors do?
In terms of equity markets, valuations are rather attractive at this moment. For 2019, we foresee a roller coaster ride. The current price earnings multiple of about 16 of the MSCI World Index is below its 30-year average. However, it is also worth noting that while valuations look cheap, we believe 2019 will see a normalisation of earnings and that 2017 and 2018 were exceptions in this regard.
With many events of significance this year, like the US-China trade war developments, major elections around the globe, political unrest in Europe and Venezuela, China's stimuli activities, and all this while factoring in a likely decline in world GDP, we believe that geographical diversification matters now more than ever, as higher volatility and liquidity risks persist to be major themes.
European stock markets continue to offer attractive entry points. Brexit and Italy are the two binary risks that prevent investors from being more constructive but could prove to be catalysts if we see some improvements. The European Central Bank will continue to be in a dovish mode throughout 2019.
For the US, we are becoming more concerned with regard to the medium to long term outlook due to the potential slowing of earnings per share growth in 2019 but the US market remains the linchpin of global equity markets for its breadth, justifying our neutral stance. The Japanese market remains attractive from a valuation and growth perspective.
With regard to emerging markets, the Asian region (especially China and Brazil) looks attractive, particularly from a valuation standpoint, notwithstanding political and trade war risks. We expect those tensions to ease but not to fade away entirely. The upside going forward should be closely linked to future growth rather than increase in price earnings multiples and hence, more volatility.
We prefer cross-sector themes such as ageing populations, disruptive technologies and new lifestyle trends. It is important to put an emphasis on high quality stocks, characterised by well diversified segments, strong franchises, low leverage, high free cash flow generation and with a focus on shareholder return.
Looking at the fixed income markets, 2018 was a very difficult year for credit but there is some hope for 2019. Wider spread levels bode well for investors if our base scenario of a slowdown but not a recession holds. US investment grade spreads are approximately 60 basis points (bps) wider than a year ago. In Europe, this is even more pronounced at around 100bps. Generally, we prefer US investment grade, especially in the two- to-five year bracket. European yields generally remain low, to be of interest. In terms of emerging markets, we remain cautious although we see new opportunities especially among the Chinese property segment.
Commodities and energy markets continue to be under pressure, led by the drop in oil prices. There are several factors affecting sentiment around oil: Venezuela (which has the world's largest proven oil reserves), Iran, Opec, US shale supply and slowing global demand. We expect crude prices to remain volatile but do not expect a sharp rebound in prices.
Which brings us to gold. In order to neutralise some of the volatility that we expect and put simply, because we feel gold should be part of everyone's portfolio in some way or form, we are positive on investing in gold. So to go from dire straits to Dire Straits, the next song up is Love Over Gold.
- The writer is head of markets, investments and structuring, Asia, Indosuez Wealth Management