Four lessons to draw from the year so far

The data table below suggests that 2018 is proving anything but straightforward, with many popular asset classes failing to deliver and some unloved ones doing relatively well. But to help clients manage and protect their wealth, advisers can perhaps draw four lessons from the market action in 2018 so far.

 

 

Performance of leading asset classes in 2018 to date

Source: Morningstar Direct. (Total returns, in sterling terms).

Four-point plan

Most advisers and clients are, in all likelihood, unlikely to be deflected from their strategic allocations by short-term whirls and eddies in the markets and that is a good thing. It keeps down the risk of being sucked into trying to time the markets and helps to limit unnecessary trading expenses and commissions for good measure.

But for those advisers and clients who do have a percentage of their assets set aside for tactical allocations, 2018 has offered four trends which should perhaps be borne in mind as portfolios are readied for the summer and then the second half of 2018 and beyond.

  1. Markets are still adapting to a world of QT

While it is interest rates that attract the most attention when it comes to central bank policy, the Federal Reserve’s switch from Quantitative Easing (QE) to Quantitative Tightening (QT) is being overlooked.

In addition, the Bank of England has stopped adding to its £445 billion programme and the European Central Bank is slowly reducing its monthly stimulus. That leaves only the Bank of Japan going all in on QE, as it continues to run its ¥80 trillion a year scheme.

The BoJ’s stimulus equates to about $730 billion a year – but the Fed will be withdrawing QE at an annual run rate of $600 billion a year from October onwards.

That is a substantial decrease in global liquidity after a long span when cheap central bank cash drove bond yields down and equity valuations up.

US investors now need to fund a near-$1 trillion budget deficit by buying this amount of US Treasuries and do so as liquidity is drained away, perhaps putting upward pressure on yields for US Government debt.

If QE really did help stocks, as seems possible, the effects of QT may already be filtering through. After all, the US stock market seem to be providing everything the bulls expected after the Trump tax cuts – rising profits, rising dividends, bumper share buybacks – except positive returns.

US Federal Reserve is still sticking to its QT script

Source: FRED – St. Louis US Federal Reserve database, Thomson Reuters Datastream. (Projections for Federal Reserve balance sheet assets based on guidance offered by Chair Janet Yellen in June 2016).

  1. Embrace political uncertainty

Most advisers and clients will run a mile when confronted by political uncertainty. Yet the UK, dogged by a tangled Brexit debate which seems to be satisfying neither Remainers nor Leavers, is performing relatively well. Brazil is doing better still, even though it is mired in an epic corruption scandal and moving toward a general election.

By contrast, nations where politics are seen as stable and helpful for markets, from India to China to Japan, are doing little to provide positive returns in 2018 – and that’s before we get to the disaster that is Argentina.

Political doubts can drive a currency down, to either provide an economic lift, via exports, or make assets look cheap to overseas buyers (as the wave of merger and acquisitions in the UK suggests). Emerging markets may therefore be interesting here, after Malaysia’s shock poll result and ahead of the ballots due in Mexico and Brazil.

  1. Valuation never matters – until it does

The battle lines remain drawn between ‘value’ and ‘growth’ investors (although some advisers and clients may view this debate as merely a semantic one and a choice between earnings increases now and earnings increases later).

The loss of absolute momentum in technology stocks (even if they are still doing relatively well) and negative returns from US, Indian and Chinese equities, coupled with the relatively solid returns from UK stocks, would suggest that ‘value’ may be asserting itself.

Professor Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio as a benchmark would suggest that US stocks may struggle to provide positive returns on a ten-year view, should history deign to repeat itself (or even rhyme).

This chart shows the next 10 years’ compound annual returns from the S&P 500, according to the CAPE multiple paid to buy US stocks at the time – and the last three times valuations were this high since 1963 all presaged poor future returns.

US stocks still look very expensive based on long-term earnings metrics

Source: econ.yale.edu/~shiller/data/ie.xls, Thomson Reuters Datastream

  1. Beware the consensus

So far in 2018, a lot of the consensus calls have failed to comprehensively deliver or at least offer clients positive returns (US stocks, tech stocks, India, China) while unloved assets (UK stocks, oil, UK property) have done relatively well.

Perhaps the message is to be prepared for anything and maintain an accordingly balanced portfolio that is as capable of protecting wealth as it is of growing it.

After all, the American writer and humourist Mark Twain once wrote: “It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so.”

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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