How to get ready for the year ahead

Regular readers will know that one of this column’s favourite market sayings comes from fund management legend Sir John Templeton, who once asserted that “Bull markets are founded on pessimism, grow on scepticism, mature on optimism and die on euphoria.

Applying this test can potentially help advisers and clients spot where value and future upside opportunities can be found, and – just as importantly – avoid areas which are so popular they could be overvalued and capable of doing damage to portfolios.

It is not easy to research an asset class and country, and what may be suitable funds, when no-one else is interested, and avoid those which everyone is talking about with great excitement. But 2018 provided examples of how it can help.

At the start of this year, the euphoria surrounding cryptocurrencies was all-pervasive. Bitcoin promptly lost 75% of its value.

By contrast, defensive equity sectors were widely viewed with scepticism at the start of the year, amid widespread optimism regarding what was termed as a synchronised global recovery. But, using the S&P Global 1200 as a benchmark, Healthcare and Utilities turned out to be the best two performing super-sectors (out of 11), while Financials and Materials (miners), both expected to do well, did worst.

A quick look at 2018 may therefore help advisers and clients to spot value and dodge the traps that 2019 may offer.

Don’t look back in anger

First things first. This year has not been easy. None of the major asset classes as a whole – equities, bonds, commodities – generated positive total returns in local currency terms. The pound’s drop boosted the value of overseas earnings but apart from select areas such as technology it was hard to find winners in 2018.

Few asset classes yielded positive total returns in 2018 (though the lower pound helped)

Source: Refinitiv data. Covers period 1 January to 13 December 2018

That may make advisers and clients wonder whether we are still in a bull market at all. Further doubts creep in when they look at major stock markets: not one beat cash in local currency terms, though again a slide in sterling increased the value of overseas shareholdings.

America did best of the major markets in 2018 but local currency returns were still weak

Source: Refinitiv data. Covers period 1 January to 13 December 2018

Equity sector trends further question the bull market. As already noted, defensive sectors led the way as cyclicals lagged and even technology lost some of its shine in the second half, amid concerns over valuation, regulatory pressure, product cycles and whether growth forecasts could be met.

Defensives beat cyclical hands down in 2018

Source: Refinitiv data. Based on the S&smp;P Global 1200 indices. Covers period 1 January to 13 December 2018

To cap it all, any advisers and clients who thought bonds would provide capital protection came unstuck. In local currency terms, only German Government paper offered positive total returns and a dash for Europe’s ultimate haven asset hardly smacked of confidence. Tighter monetary policy and signs of wage inflation – plus fears over whether tariffs would nudge prices higher more generally – took their toll.

Bonds offered little by way of capital protection in 2018

Source: Refinitiv data. Covers period 1 January to 13 December 2018

The way ahead

Analysis of those performance statistics means this column currently sees the major asset classes like this as we head into 2019, using Sir John Templeton’s four phases as a framework.

Sir John Templeton’s four market phases as seen today

Euphoria is a lot harder to find than it was a year ago.

This in itself could be a good sign for advisers and clients, since good news stories seem to be relatively few and far between, at least using the mainstream press’ financial coverage as a yardstick.

That said, US stocks – and still tech stocks and the FAANGs in particular – as well as growth and momentum styles are still very popular.

By contrast, emerging markets – a consensus favourite in January 2018 – are out in the cold after the summer rout. The loss of faith in Bitcoin is now tangible. Financials stocks are unloved after a horrid year and fat yields and low multiples of book value mean banks may pop up on ‘value’ screens – even if ‘value’ remains intriguingly out of favour.

But if advisers and clients are really looking for an area where pessimism may mean value is available, look no further than the UK, wracked as it is by the Brexit debate – although admittedly you could have said the same at this time last year, to no great effect. It will be interesting to see if the FTSE 100 confounds its doubters in 2019 and beyond, whether a deal is struck with the EU or not.

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.

Top