Annual financial forecasts are fraught with error, and our investment strategies aren’t built with the expectation that we can accurately forecast the near term.
Instead our goal is to better understand the range of likely outcomes that investors can expect in the coming year and to help them prepare for any given market scenario.
Last year did not end smoothly. Global equity markets had a turbulent fourth quarter, with volatility registering 16.5% on the MSCI All Country World Index. No doubt this led to sleepless nights for investors, advisers, and market observers. But what continues to keep us up at night?
When it comes to trade, the US-China relationship is an area of particular concern. When trade tensions between the world’s two largest economies escalate it threatens global growth. But China isn’t the only issue.
As the IMF noted in October 2018, the world economy faces many challenges, including rising trade barriers disrupting the supply chains crucial to the past decade’s global growth. As well as affecting consumer prices, they can limit business spending, which has a longer-term economic impact.
Brexit, which challenges the free flow of goods, services, capital and labour across EU borders, is one example. Trade tensions also simmer between the US and the EU. Meanwhile the Nafta replacement agreement informally agreed to by the US, Mexico, and Canada – a rare positive in an otherwise troubling environment – is subject to important details being worked out before it is officially ratified.
As trade is currently estimated to contribute 55% to global GDP, it is hard to overstate how important it is to global growth or how disruptive continued trade conflicts could become.
Monetary policy also matters. After a decade of monetary stimulus that encouraged investment in stocks, bonds, and other risk assets in the post-crisis period, the tide of quantitative easing has been ebbing and 2019 will see it ebb even further.
In December 2018, the European Central Bank ended its asset purchase programme and the US Federal Reserve continues to shrink its balance sheet, which is down to $4tn from roughly $4.5tn at the end of 2017.
If quantitative easing was a tailwind for risk assets, then its reversal will present a headwind. Rate rises present another potential stumbling block.
The Fed has raised interest rates by 0.25% nine times since December 2015, most recently just before Christmas. While rates are not expected to rise in such rapid succession in 2019, it seems clear that the era of extremely low rates is behind us.
Trade and monetary policy may be two of the biggest challenges ahead, but there are a host of others. Not least is whether fading stimulus from US tax cuts makes us realise it was simply a temporary sugar high.
Political uncertainty is present on both sides of the Atlantic. Will Eurosceptic forces gain ground in European elections in the coming year and accelerate fragmentation? Likewise, will the US government become further mired in gridlock now that Democrats control the House?
Will the US address large structural deficits to build a cushion of protection against a future downturn? Or does a split government make that outcome less likely?
It is only natural to ask whether there is anything we can look forward to in 2019. The answer is a resounding yes. All the challenges described above are an opportunity for good news.
Markets have a built-in expectation for how these issues will be resolved. To the extent resolution happens in a way that is better than expected, investors are likely to be rewarded.
For example, if China and the US resolve their trade dispute in a timely fashion, equity markets would likely rally. The challenge for investors is determining how the year ahead will unfold relative to the expectations already in place.
That ultimately means learning to accept uncertainty. And the best way to deal with ongoing uncertainty in financial markets is to check your emotions at the door and stick to the well-thought-out investment plan you’ve built, the one that acknowledges that markets will rise and fall. Reacting rashly to either scenario isn’t a likely path to success, or to a good night’s sleep.
Tom Lee, managing director of investment strategy and research, Parametric Portfolio Associates
Column sponsored and supplied by Eaton Vance
Sources of all data: Parametric, Bloomberg. As at 31/12/2018. For professional clients / institutional investors use only.
This material is presented for informational and illustrative purposes only and should not be construed as investment advice, a recommendation to purchase or sell specific instruments, or to adopt any particular investment strategy. It has been prepared on the basis of publicly available information, internally developed data and other third party sources believed to be reliable.
Eaton Vance Management (International) Limited (EVMI) is not responsible for any subsequent investment advice given based on the information supplied. Past performance is not a reliable indicator of future results. This material is issued by EVMI who is authorised and regulated in the UK by the Financial Conduct Authority. Visit EVMI at https://www.eatonvance.co.uk
MSCI All Country World Index is an unmanaged free-float-adjusted market-capitalisation-weighted index designed to measure the equity market performance of developed and emerging markets.