View from the CIO: A healthy dose of volatilityPublished on 28 Jan 2019
2018’s instability resets valuations, presenting opportunities ahead
There are no two ways about it, 2018 investment returns were disappointing. All major asset classes posted negative real returns and, after a decade of virtually unchecked equity market gains, investors are again feeling the pain of violent gyrations in value.
For the first time since 2008, the S&P 500 failed to rise in a calendar year, returning - 4.4% in US dollars. Many markets in Europe and Asia retreated by more than 10%, with some emerging markets down more than 30%, with little protection from bonds, commodities or hedge funds.
All this has served as a stark reminder for investors of the potential for volatility, having lain dormant for so long, to re-exert itself and dampen sentiment. Markets were roiled by tighter financial conditions, slower global growth and geopolitical risks, particularly an escalating trade war between the US and China.
Looking ahead, investors should avoid being distracted by short-term periods of market stress. Indeed, such drawdowns in value often represent compelling opportunities for disciplined long-term investors. Sure, global growth is moderating, but it is not collapsing and is likely to sustain a steady pace. Pockets of the equity market have over-reacted to growth concerns and now offer attractive long-term returns.
Value managers seek out strong, growing businesses that are generally overlooked by the market at large. In 2018, this has come at a cost for US value managers who have underperformed their benchmarks as investors have favoured more defensive, ‘quality’ companies. If the slowdown is not as severe as the market has assumed, the upside reaction of these stocks could be quite compelling.
Emerging market assets suffered double digit falls in value last year. China in particular faced both external and domestic challenges in 2018, plagued by an ongoing trade war with the US and internal financial deleveraging. The market has reacted by punishing assets that are linked to the Chinese economy.
The authorities in Beijing are now focused on stabilisation. Having reflated their economy in 2008, 2013 and 2016, they are working towards a more sustainable growth path, less reliant on regular injections of credit. While positive, this is a long-term strategy which will require short-term tolerance of slower economic growth. As 2019 progresses however, these policies will start to take effect.
As for trade wars, protectionism is unlikely to cease to be a feature of the Trump administration. It is hard to imagine, though, that such domestically damaging policies will be implemented as the Presidential cycle matures.
In general, headwinds like these for emerging markets are expected to be less severe in 2019 than 2018, with the potential for tailwinds – which help not hinder markets - to emerge and re-invigorate depressed investor sentiment.
The outlook is brighter than the pessimistic market consensus would imply. In an environment where the monetary tightening cycle in the US slows and there is a reprieve – if temporary - in relations between US and China, emerging market assets should become appealing once again. Coupled with buying opportunities in the equity market which offer attractive long-term returns. There are plenty of reasons to be optimistic about the future.
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