Companies' underlying fundamentals remain supportive and markets are more attractively valued than they have been, according to Columbia Threadneedle’s Mark Burgess, but there is a lot to worry about and investors should be prepared for further volatility in 2019.
Burgess, who is the deputy global chief investment officer of the asset management house and co-manager on the £1.3bn Threadneedle Managed Equity & Bond fund, said the team is “nervously optimistic” about the outlook for markets next year.
“As key risks, rising interest rates, trade wars, the EU fragmentation and high levels of indebtedness globally give us some concerns, but we feel nervously optimistic about markets,” Burgess said.
“Clearly having had a strong year in 2017, 2018 has proved to be much more challenging.”
When it comes to economic growth and inflation, Burgess noted the 2019 outlook is less even than it was in 2017 and 2018, with global growth expected to be average but less uniform than in 2017. Meanwhile, inflation set to remain low for a while.
“We expect middling economic growth. This will allow firms to continue generating healthy profits and profit growth, but this is likely to benefit equity holders rather than credit holders,” he said.
“Valuations are currently fair, so we see 2019 as likely to provide a continuation of 2018’s benign environment, all things being equal.”
Despite the warning signs the team monitors that would suggest a sharp turnaround are not all flashing red as we welcome the new year, Burgess noted there are a number of risks he is watching closely.
Performance of indices in 2017 and 2018
Source: FE Analytics
These include an overstimulation of the US economy in order to continue its strong growth and various geopolitical issues such as the escalation of the US-China trade war or the rising tensions between US and Saudi Arabia.
“Clearly, we have a lot of geopolitics to deal with such as ‘Trumponomics’ [US president Donald Trump's economic policies]. Growth and outperformance of the US economy are pretty important to Trump and the stimulus of the US economy in 2018 has presented financial markets with some concerns,” he said.
“Asia and the emerging markets are quite exposed to ‘Trumponomics’ from a stronger dollar perspective and that has unsettled some of the emerging markets specifically.”
In Europe, Burgess said issues such as the Italian budget, the rise of right wing politics and ripples from whatever Brexit deal is agreed make fragmentation of the European Union a key risk.
He added: “Brexit is at the eye of the storm at the moment, who knows how that is going to end but it is certainly posing some economic headwinds both in the UK and also to Europe.”
In his outlook for global equities, Burgess reminded that in 2018 markets had a difficult time in most places, with the exception of the US.
However, having strongly outperformed the rest of the world, Burgess warned the world's largest economy is now beginning to slow down.
“A broad indicator shows us the US will slow down going into 2019,” he said.
“While in the US growth will moderate during 2019 as the impact of fiscal stimulus rolls off and the Fed raises rates in line with market expectations [keeping inflation in check], we expect the relatively good economic growth generated in Europe to continue into next year.”
US interest rates over 10yrs
Source: St Louis Fed
Noting rising interest rates could impede both equities and credit – prompting negative returns from duration on the credit side and hurting equities as investors search for yield from less risky assets – Burgess said the team maintains a preference for equities as well as commodities and commercial property over credit.
From an appetite point of view, the team remains “fairly neutral” and continues to hold a positive stance towards European, Asian and, particularly, Japanese equities within the favourable allocation to equities overall.
Burgess also highlighted the bout of volatility experienced by markets in 2018 but argued that it doesn’t mark the end of the cycle but that the recent market pullback represents an opportunity.
With the reset in the valuations of attractive secular growth stories, he emphasised that this backdrop is an ideal hunting ground for bottom-up investors capable of identifying stocks trading at below their intrinsic value.
“Any widening in the dispersion of returns brought about by a sustained rise in volatility should further increase opportunities for active managers,” he said.
“We continue to favour capital-light, high-return businesses capable of growing market share and sustaining pricing.
“As value chains continue to evolve, traditional business models are challenged, and technology comes of age, those companies that are able to innovate should continue to grow.”
He added: “Corporate profits are growing, companies are behaving in an equity-friendly way, valuations are supportive and bond yields should not rise aggressively – in short, we can expect more of the same in 2019.”
Performance of fund vs sector over 5yrs
Source: FE Analytics
Over five years, Burgess' Threadneedle Managed Equity & Bond has delivered a 27.41 per cent total return compared with a gain of 22.36 per cent for the average fund in the IA Mixed Investment 20-60% Shares sector.
It has an ongoing charges figure (OCF) of 0.81 per cent.