Quarterly Investment Update Q4 2018
Global economic growth continues but tighter monetary conditions and geopolitical concerns are weighing on markets.
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Investors remained cautious in the fourth quarter of last year in an environment of less accommodative monetary policy, ongoing trade tensions and Brexit uncertainty.
Markets fell sharply early in October and volatility continued throughout the quarter to the end of December. As the year drew to a close, sustained falls in December – particularly in the second half of the month – saw all major equity markets finish significantly down. Conversely, it was a good quarter for bonds, with gilts and Treasuries both offering investors a strong, positive return.
Negative news flow worries investors
Reasons for the investor jitters are multifarious. Rising interest rates in the US suggest higher borrowing costs, which could have a knock-on effect on company profits as well as potentially dampening consumer demand. Rate rises are also fuelling a stronger dollar, which can be difficult for emerging market economies that have large amounts of dollar-denominated debt, while the Chinese economy has been slowing sharply over 2018.
In the background, political concerns are also undermining investor confidence. Persistent trade tensions between the US and China continue to raise fears on the future of global trade and the global economy. Despite some positive movements – the US announced positive talks at the G20 conference at the end of November, and China announced reduced tariffs on US automobiles in December – the atmosphere remains fraught.
In Europe, Italy’s long-running budget dispute with the European Union (EU) came to an end after the populist government agreed to postpone some of its planned spending. This provided some relief for European markets but the eurozone is still vulnerable to slowing growth and economic problems in China and the emerging markets.
Coutts Investment Strategist Lilian Chovin says the bank has acted to position portfolios for the current economic outlook.
“We reduced the overall level of risk in our funds and portfolios gradually throughout the year, including in December, by shrinking our exposure to European equity and financial credit, and holding the proceeds in cash,” he says.
“We are still modestly tilted towards risk assets but have recently focused our exposure in more defensive areas. This will reduce the impact of volatility on portfolios and give us a reserve of cash to take advantage of opportunities quickly as they arise in the coming months.”
Central banks hold their nerve
Despite opposition from President Trump, the US Federal Reserve (Fed) raised interest rates to a range of 2.25% to 2.5% in December – the fourth hike in 2018. However, Fed officials suggested a softer approach to future increases, focusing on economic data to avoid over-tightening that could damage economic growth.
Elsewhere, the European Central Bank (ECB) confirmed that it is ending its net asset purchase programme. The ECB has stopped its bond-buying scheme, worth €30 billion a month, despite a recent slowdown in the region’s recovery. Although this is a significant move, the bank kept interest rates on hold and we think the possibility of a rate rise in the near future is slim.
In the UK, consumer price inflation fell from 2.4% in October to 2.3% in November, led by lower energy prices. The Bank of England kept interest rates at 0.75% in December, but governor Mark Carney suggested there could be a faster pace of rate increases if the UK managed a smooth exit from the EU.
UK gilts and US Treasuries offered improving returns over the quarter as investors sought the relative security of government bonds in the face of unpredictable equity markets. The yield on America’s 10-year Treasury bonds fell below 3% at the start of December for the first time since September, as bond prices rose.
We see government bonds as offering poor long-term returns but have increased our holdings over 2018 as they provide diversification in volatile conditions. In the meantime, while tightening monetary policy is likely to lead to sharper short-term rises and falls in equity markets, we remain confident in the economic outlook. Given recent market falls, any positive economic data could help investors re-focus on the fundamentals and support equities.
Brexit dominated UK headlines over the final three months of 2018. For investors, the negative sentiment caused by the fluid political landscape weighed particularly on sterling. However, Brexit isn’t a major driver of equity market performance. There are some sector-specific effects on industries such as banking and property, but falls in UK equities more generally appear to be driven by the same factors fuelling falls elsewhere. Indeed, UK equities fared somewhat better than the US and Europe over the quarter.
Consumer confidence in the UK fell to its lowest level in almost a year as Brexit uncertainty continued. The UK economy has slowed but is still growing at an annualised rate above 1%. Unemployment is low and wages are rising at their highest level for almost a decade. Despite some negative headlines and profit warnings, as well as ongoing problems with high-street retailers, company profits have remained buoyant across most sectors.
A slippery slope?
Oil prices struggled to recover after a steep sell-off pushed them to their lowest point of the year, as Brent crude fell below $58 a barrel at one stage. Various factors have resulted in oil prices falling by over a third since early October, including a lingering glut in supplies and American pressure on Saudi Arabia to keep energy costs low.
Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.
A range of key economic indicators shows continued growth despite markets being weighed down by rising interest rates and geopolitical issues.
At Coutts we have reduced the overall level of risk in our funds and portfolios to reflect the changing landscape and limit any negative impact. These changes should also help us quickly take advantage of new opportunities as they arise this year.
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