UHY Hacker Young | Chartered Accountants

Investing – The Bigger Picture

20 February 2019

Our blog this week is by James Robertson, Chartered Financial Planner with Active Financial Planners based in Stockton-on-Tees. James offers an insightful view of the global financial market and its potential effects on our investments in the year ahead.

It’s fair to say that 2018 brought less joy for investors worldwide than expected.

The only consolation is it came after two pleasing years of investment returns and did not reflect similar downward moves across the global economy. Indeed, the state of capital market sentiment could not be more contrary to one year ago, while the rate of economic growth has merely fallen back to the previous state of ‘slow but steady growth’ which has given us one of the longest economic cycles in recent history.

Admittedly, from a UK perspective, this early part of 2019 appears more precarious, given that most of us would have expected to know by now what shape Brexit would take. It is not surprising that economists’ outlook for the UK is very hesitant, with the majority forecasting a procrastination of the exit proceedings leading to more or less a repeat of 2018 with subdued, below-potential growth.

Outside the UK, where the 2019 outlook was not overshadowed by such a fundamental decision, the Federal Reserve’s conflicting signals unnerved investors. Instead of a pleasing year-end “Santa Rally”, stock markets – particularly in the US – experienced a rollercoaster of flash crashes and flash recoveries.

“Chimerica” *

Further East, China’s leadership re-emphasised its determination to follow its long-term structural reforms towards more “self-reliance” with less dependence on credit growth and export surpluses. Meanwhile, policy action by the Chinese central bank and the bank regulator informs us that the leadership appears to be prepared to do what it takes to counter the inevitable economic reform pain, but without a repeat of the 2015 credit binge of large and state-owned enterprises. Early signs of a re-acceleration of the services sector bode well in this respect.

Over in the US 2019 started with a reminder for the Trump administration that US wealth may be more dependent on trade with China than it would like to admit. Declining Apple iPhone sales in China led to a 10% fall in Apple’s share price, costing investors more than $70 billion in notional valuation losses. It may therefore not be surprising that President Trump is making increasingly optimistic (Twitter) statements about the prospects of a US -Sino trade settlement.

US central bank chair Jerome Powell calmed the other major pre-Christmas stock market concern (of a monetary policy error through overtightening) by stating that the US central bank would take a “patient” approach to raising interest rates and to unwinding its post financial crisis stimulus. This was very welcomed by markets as it coincided with surprisingly strong US jobs and wage growth data for December which would otherwise have further fueled market concerns over further interest rate hikes. In tune with the previous week’s market volatility, stock markets rallied by up to 4% on the day, leading to a strong start to 2019 for equity investors.

What may this year bring?

A strong first few weeks in 2019 does not make a strong year, but the series of recent upward surge days informs us that we are not alone in judging market valuations as having undershot economic reality as much on the downside towards the end of 2018 as they overshot it at the turn of 2017 to 2018.

Overall though, developments in 2019 have provided us with more reassurance that 2018 market action was excessively emotional in light of the likely future path of global economic growth: not back to the ‘old normal’ as quickly as perhaps anticipated by many a year ago, but nevertheless steady and expansionary – rather than falling off a cliff towards global recession.

Where does that leave us? Are we expecting a much better 2019 for Britain’s economy than others?

Not exactly. However, we’re relatively positive on UK assets – despite all of the negativity as they seem to be currently trading at values below what even the dourer Brexit outcomes could justify. Mild, barely positive growth this year wouldn’t be good, but it would be much better than what is currently priced in by capital markets. Current valuations seem to be pricing-in an unrealistic drop-off in activity. Just like with global markets, we think this is more to do with the increase in risk premium (the amount investors expect to be paid for tolerating a certain level of risk) than actual recession expectations.

Once investors realise that Britain hasn’t fallen off a cliff, there’s a good chance that asset values will rebound, adjusting to lower – but not catastrophic – economic levels. Even if Brexit ends up being harder than we expect, there could still be enough of a rebound to bring confidence back into markets.

Besides, there are silver linings to the Brexit cloud too. Uncertainty has been the biggest thing holding back business investment for the past two years, but sooner or later this uncertainty will have to fade.

So, anything other than a crash Brexit (disorderly no-deal without giving businesses time to make preparations) is likely to see business investment increase – if for no other reason than it can’t get much lower.

Even in the event of a positive surprise, however, not all assets are likely to see the same rebound. Companies with large overseas revenues are likely to be stable or better (particularly if sterling weakness continues) even if domestic demand drops off. Potentially the same is true for exporters, and particularly manufacturers, who have benefited greatly from sterling’s weak value since the 2016 referendum.

So, while the moves around the end of 2018 may have looked frightening, they are still consistent with our overall investment view. Which is: markets oversold in 2018 and valuations are now below what is justified by the global economic outlook. We do see signs of slower economic growth and an increase in recessionary risks should the US/China trade wars remain unresolved. But there is little evidence of a looming crisis.

This recent downside imbalance seems to be causing investors to begin reassessing valuations and some to eye selected opportunities. Companies will start releasing quarterly earnings for Q4 2018 in the next few weeks, so that data will provide a good indication of future market direction, and we believe there will be more pressure from businesses to push politicians to resolve trade wars, which could ignite further upward pressure.

Final thoughts

All in all, my view is as ever (and after almost 30 years of dispensing the same advice I don’t think it will ever change!):

  1. Have patience. Invest for the medium to longer-term and you shouldn’t go far wrong
  2. Invest within your risk profile. Don’t take silly risks and properly diversify your investments. No one investment can do it all.
  3. If it looks too good to be true, then it probably is
  4. Ongoing costs are a tax on your investment, and no-one likes paying too much tax
  5. Keep sufficient monies in readily accessible cash investments – so you don’t need to access a medium-term investment in the short term
  6. Never ignore the effects of inflation
  7. Never forget it’s your money. The others are just looking after it for you

Please note: The data used is sourced from Bloomberg/FactSet and is only valid for the publication date of this document.

The value of your investments can go down as well as up and you may get back less than you originally invested. The information herein is not an investment recommendation and should not be used in making an investment decision. We recommend you take advice from a suitably qualified Independent Financial Adviser before investing.

* Dr. Niall Ferguson: http://www.niallferguson.com/journalism/politics/not-two-countries-but-one-chimerica

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