Following a 2017 of relatively benign market conditions characterised by low volatility, the year has turned out to be more eventful with two significant sell-offs during the course of 2018.
Concerns over a burgeoning trade war between the US and China, the ongoing Brexit negotiations, quantitative tightening by central banks and a budget stand-off between the EU and Italy have sapped investor risk appetite despite many positive fundamentals.
In recent months the escalation of the trade war situation and concerns that the Federal Reserve’s rate-hiking regime is going too fast have prompted a profound dip in investor sentiment.
As such, global equity markets have turned in a flat performance during 2018, with the MSCI AC World index up by just 0.23 per cent (as at 14 December).
Performance of index YTD
Source: FE Analytics
After receiving a one-off boost from president Donald Trump’s tax reforms, the US equity market appears to have run out of steam more recently and some managers believe that it could fall into step with other global markets.
Chris Lees, senior fund manager of the £2bn JOHCM Global Select fund, said while the US has still managed to outperform most other markets despite the recent sell-off, it is now “statistically stretched and due a period of mean reversion”.
“The problem is we do not know if this will be because the US equity market falls to catch up with the rest of the world on the downside, or if the rest of the world rallies to catch up with the US,” he said. “What we do know is that our process continues to prefer Japan over Europe or emerging markets and this remains a non-consensus portfolio position with which we are very happy.”
What has been notable during the most recent sell-off is the change in market leadership in the US.
The high-growth FAANG stocks – Facebook, Amazon, Apple, Netflix, and Google-parent Alphabet – that have led the US market in the past few years have endured a much more difficult time of things recently.
“We have been experiencing a narrow market, with the FAANGs explaining most of the stock market returns,” said Hermes Investment Management head of global equities Geir Lode. “However, we believe we are set for a broadening in the market. At the same time as seeing early signs of weakness in the FAANGs, other pockets of the market have very attractive fundamentals.”
Indeed, Lode – who manages the $177.5m Hermes Global Equity fund – said that there could even be a reversal in style performance if the dominance of growth investing comes to an end as rates continue to be lifted to more normal levels.
With the exception of 2016 and 2008, the MSCI AC World Growth index has outperformed its value counterpart in each of the past 10 calendar years, as the below chart shows, and is set to outperform again in 2018, having delivered a total return of 1.65 per cent – in sterling terms – compared with a loss of 1.29 per cent for the MSCI AC World Value index.
Performance of indices over 10yrs
Source: FE Analytics
“After a long period of low real interest rates resulting in growth outperforming value stocks we believe value is inexpensive versus growth,” said the Hermes fund manager. “For example, we are seeing attractive investment opportunities in the oil services sector and US regional banks.
“In Japan we are also finding stocks with strong fundamentals at attractive prices. We believe 2019 will be a strong year for investors focusing on a wider range of fundamental characteristics.”
Additionally, Lode warned that the fundamentals for different assets had changed with the prospect of a positive real return through investing US Treasuries.
Indeed, companies now face a higher cost of debt posing a new challenge for businesses, while political uncertainty and a potential trade war could further increase the cost of doing business, according to the manager.
Yet, Jeremy Podger, portfolio manager on the Fidelity Global Special Situations fund, says equities remain attractively-valued relative to bonds.
The FE Alpha Manager said that next year has the potential to be a good year for equities supported by decent earnings growth, although much depends on the actions of policymakers.
“On overall market levels, earnings-based valuations are not problematic,” he said.
“The current trailing price/earnings [P/E] ratio for global equities is around its long-term average and decent company earnings growth in 2018 has translated into much lower forward P/E multiples for both developed market equities as well as emerging market equities. This has brought in a margin of safety that we did not have in 2017.
“Notably, equities remain relatively attractively valued versus bonds from an asset class perspective.”
Indeed, Invesco Perpetual chief economist Nick Greenwood said that while there have been many difficulties for investors, it is unlikely that they will be repeated in 2019 next year.
“2018 has been a year of turmoil with weakness in the bond markets and two significant selloffs in equity markets,” he said.
“In between there were crises in Venezuela, Argentina and Turkey; ongoing Brexit negotiations; a strong rise in the price of oil; and disruptions created by US president Donald’s Trump’s repeated trade measures — all set against a backdrop normalising US interest rates.
“However, 2019 promises to be much calmer, in my view.”
He added: “Though individually damaging, it is my view that these geopolitical events will prove to be no more than waves on the surface of the tide which is the record-breaking expansion of the US business cycle.”
Rather than worrying about geopolitical events, investors should pay greater attention to more immediate trends in markets.
“After a bearish end to 2018, financial market participants are preoccupied with the question of whether a global downturn is imminent,” said Neil Robson, head of global equities at Columbia Threadneedle.
“Yet they should be asking a different question: have they accounted for the way that technology and other factors are transforming business models?”
As the below chart shows, the Nasdaq Composite index – which has a higher weighting to IT companies – has significantly outperformed the S&P 500 over the past 10 years.
Performance of indices over 10yrs
Source: FE Analytics
He explained: “After all, the average company's earnings have moved sideways for a decade. Technology firms are among the few 'superstars' that have famously grown earnings in this time, although in fact there are less well-known companies in almost every sector that have done so.”
Robson said the firm are investing in ‘tomorrow’s superstars’: companies with a competitive edge that typically have barriers to entry, can gain market share and harness transformational technology.
“Looking to 2019, one should not be fooled into thinking that cheap companies represent an attractive buying opportunity,” he added. “Innovators are disrupting markets, undercutting prices and driving down profit margins.
“In 2019 we will remain dedicated to pinpointing companies that successfully operate in difficult-to-access areas. They are overwhelmingly harnessing societal change and technology, instead of swimming against the tide.”