After a rough end to 2018, markets have staged an equally dramatic rebound. As prices fell, it appeared that the sell-off was overdone and valuations became more attractive – leading investors back into the market.
Recent changes in sentiment were driven be three factors that we believe still have the capacity to influence markets this year.
The major catalyst for the rally was the change in the US Federal Reserve’s (Fed’s) monetary policy outlook. In early January the Fed revealed that they would be more flexible and abandon any further interest rate rises in the near future.
A more accommodative monetary policy means easier financial conditions for companies, giving some reprieve to equities.
However, despite this dovish cooing the Fed will continue to be driven by data. This means interest rates could start rising again should the economic backdrop suggest that economies can handle a bit of tough love.
It’s clear that President Trump wants to conclude negotiations, while the Chinese authorities – facing a domestic slowdown and headwinds from an ageing business cycle – are also keen to get matters on a surer footing.
Positive news on trade negotiations is now largely priced-in by the recovery in asset prices, so any negative news could lead to a substantial wobble in confidence. We would see this as a temporary blip, though, and believe that momentum will continue into the summer.
We don’t know the details of any potential trade deal, if one is agreed. But an agreement would be positive for investor sentiment not only in Asia, but also in Europe’s export countries like Germany. This would balance somewhat the recent cautious view of spending plans and business outlook. Consumer confidence in various countries has already taken a hit and, although this is probably only temporary, it is a risk we are monitoring.
It’s worth bearing in mind, however, that while a trade agreement would settle markets in the short term, China’s ambitions remain a potential source of conflict with the US. As they pursue the goals set out in the ‘Made in China 2025’ agenda there will be further potential for sparks to fly.
The perceived instability of the US government at the end of 2018 was exacerbated by the US shutdown and the rotation of senior members in the Trump administration – the resignation of US defence secretary Mattis was making headlines at the end of December. Since then, President Trump has made strenuous efforts to project a more settled demeanour, and a major escalation of the shutdown was avoided.
While concern over the political mood in Washington still has the potential to knock investor confidence, ultimately economics drives markets. Following market turbulence at the end of the year, and with an eye on the potential impact for the US consumer – and voter – the US administration will focus on avoiding a recession and keeping the economy growing in the lead-up to the president’s re-election campaign in 2020.
Looking ahead – where next for markets?
Overall, the environment for risk assets now looks fairly balanced. The economic slowdown that our in-house indicators identified last year is still ongoing, but on the other hand central banks are now more dovish than anyone could have predicted two months ago. And given the current outlook for low inflation, there’s no reason for central banks to change this stance anytime soon, which is positive for financial markets.
Many investors remain cautious about the economic outlook. In line with our contrarian investment principles, we see this as a signal to maintain confidence in risk assets.
We continue to think that it makes sense to own quality assets. Quality remains a top criterion, be it in our direct equity investments or in our fund investments.
This environment calls for an overall balanced positioning of our portfolios. Risk assets – mostly equity and selective credit assets – currently account for a little over half a typical balanced portfolio – with the other half invested in government bonds, high grade credit and alternatives to provide some diversification. We also hold a cash reserve for when we want to act quickly on new investment opportunities.
Over the coming quarter, we will be on the lookout for anything that could shift focus from short-term political spats to economic fundamentals. While Brexit and its influence on UK assets remain unresolved, global investors will be looking for confirmation that the global economy is stabilising or bouncing back.
Our analysis will as ever be focussed on identifying the underlying structural investment themes that often tend to be pushed to the background by alarming news headlines. Our in-house indicators will help us navigate any choppy waters and keep the focus on the main drivers of the global economy.
While markets rebounded strongly in the first quarter of 2019, we believe the key issues that drove negative sentiment still have the potential to hit markets. We are taking a relatively balanced view of markets, with a slightly higher exposure to cash to allow us to take advantage of any opportunities presented by the more mobile markets of 2019.