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December Investment Strategy: A Year of No Returns

Key points

  • When the quantitative easing goes out: 2018 has been unique in terms of the breadth of negative returns across assets.
  • The overarching theme of 2019, if not beyond, is likely to be underwhelming asset returns.
  • The change in tone at the December Federal Reserve meeting should help contain downside growth scenarios.
  • Our asset allocation remains unchanged, with modest risk appetite, partly shifting from US to emerging market equities and underweight investment grade

2018, a frustrating year for investors…

As the year comes to an end, we look back in this Monthly Investment Strategy at macroeconomic and market performance and surprises. Such a post mortem analysis is a healthy, usually humbling exercise, and is often rich in lessons.

While 2017 was an enjoyable synchronisation of positive growth momentum and strong performance of risky assets, 2018 will hardly be missed. Equity returns are closing the year poorly across the board, with the US outperforming and defensives posting marginally positive returns. Breaking down global equities’ total returns
(-6.7% year-to-date at the time of writing), robust earnings growth delivered close to 19.4% and dividends contributed around 2.4%. But despite this strong fundamental backdrop, valuation multiples contracted sharply by 23.7%. This de-rating of equities can be attributed to a mix of higher risk-free rates and poor investor sentiment. In particular, on top of lacklustre growth, euro area equities disappointed in the wake of political risk. Emerging market equities, meanwhile, suffered from both tighter financing conditions and concerns around trade protectionism.

Credit inevitably succumbed to equity contagion, especially in the last quarter of 2018. Over the past month, the risk-off mood pushed credit returns deeper into negative territory. The pain has been particularly acute for high yield, upending the reflation trade that saw high yield outperforming investment grade for much of 2018. The repricing is nothing short of dramatic with euro credit spreads almost doubling from their February lows.

…and a challenging 2019 ahead, especially as our risk scenarios are already unfolding

As we explained in our 2019 Outlook published last month, some of this unimpressive market performance stems from the forward-looking feature of asset prices. In this sense, 2017’s market gains could be explained by realistically positive expectations for 2018 top-line and earnings growth, whereas risky assets would have suffered this year as a result of the anticipation of the upcoming global economic slowdown. We however believe that the rise in cross-asset correlation (which limited the benefits of diversification in 2018) and in market volatility (first with a spike in February then more gradually and persistently since early October) point to an alternative explanation: the end of the global expansion of central banks’ balance sheet and the reversal of the liquidity tide of which Warren Buffet famously warned. If this is the case, 2019 and possibly beyond could prove just as challenging with low returns and high cross-asset correlations.

2019 may prove all the more challenging if the two risk scenarios we outlined in our 2019 Outlook, and which have already begun to unfold in December, gain further traction: the US Federal Reserve (Fed) losing confidence and the Eurozone economy exiting the cyclical expansion first even though it entered the cyclical upswing last.

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