Andrew Yeadon, the chief investment officer for Nedbank Private Wealth, shares his thoughts on the first six months of 2019 and what that might mean for the remainder of the year.
As financial markets crossed the midway point of 2019, with the notable exception of the pullback in May, investors can reflect on a very positive second quarter and an even better first half. Most asset classes, regions, sectors and styles delivered decent gains over both periods, with equities and riskier assets generally producing the highest returns.
Focusing on the second quarter, economic data came through a bit softer than expected, which prompted economists to downgrade forecasts for global growth in 2019. Company analysts also moderated their expectations for corporate earnings, while the breakdown of US-China trade talks and Trump’s threats to escalate tariffs regularly made the headlines. While investors managed to maintain a positive outlook through April, by May they were starting to focus more on the negatives, which led to a sharp drawdown, with risk assets being sold off in favour of safe havens. However, by early June the central banks had stepped in and lifted the gloom. The first sign of this shift came in a speech from Federal Reserve Chairman Powell, when he signalled the likelihood that US interest rates would be cut in the second half of 2019. Other central banks followed his lead with their own “dovish” pronouncements, which effectively restored investor confidence and helped risk assets to recover lost ground.
Over the quarter, there wasn’t a great deal of difference between the aggregate returns of equities and bonds, as the downward adjustment in interest rate expectations helped both asset classes more-or-less in equal measure.
“While investors managed to maintain a positive outlook through April, by May they were starting to focus more on the negatives.”
Within equities, the standouts were European equities, which were stronger than most other regions, in part due to a firmer euro. At the other end of the spectrum, Asian equities lagged on lingering worries about trade tension and its impact on the Chinese economy. Perhaps surprisingly, at the sector level the best returns came from cyclicals, such as Materials, Consumer Discretionary and Information Technology, while stable earners, such as Healthcare and Utilities, generally disappointed. Finally on style, Growth continued to outpace Value, while Larger Companies performed better than Smaller Companies.
Within fixed income, the shift in interest rates helped longer dated bonds outperform shorter maturities, all other things being equal. The extent of the shift took us a little by surprise, and our bias towards the shorter end of the curve detracted value. However, tighter credit spreads helped investment grade corporate bonds outperform, so our tilt towards credit was helpful. Alternative asset classes, or at least the types included in our clients’ portfolios, also delivered strong returns. One of the common factors across the investments we have made in renewable energy, infrastructure, asset-backed lending and property is that they all deliver high income yields (typically 6% to 7% per annum). As the yields on government bonds have been bid lower, the value of the strong cash flows delivered by our alternatives have increased, which was recognised in the strong gains most of them made over the quarter.
With the Federal Reserve’s shift in policy reducing interest rate support, the US dollar declined against most currencies, in a break from recent trends. Among the majors, only two currencies did worse than the US dollar, with the UK pound and the Chinese yuan suffering from country specific uncertainties relating to Brexit (pound) and the US–China trade war (yuan).
Unresolved trade tensions and weaker business confidence indicators have seen forecasts for global growth, inflation and interest rates fall significantly over recent months. With slower growth expected everywhere, it seems likely that inflationary pressures will remain muted, encouraging central banks to either maintain, or in some cases, ease monetary policy over the coming months.
In our view, the advanced economies are in the midst of a long term secular growth stagnation that they can only escape temporarily when they pursue large scale fiscal expansion programmes fortified by aggressive near zero interest rate policies. This is in part the legacy of the Great Financial Crash and subsequent deleveraging, but it is also a consequence of global overcapacity and aging populations.
Although growth may be slowing as the effect of the US fiscal splurge fades, we do not believe a recession is imminent, which some have suggested. In fact, we believe the shift towards low interest rates will be supportive for the global economy and risk assets in general.
While we expect global corporate earnings growth to be positive in 2019, it is unlikely to be particularly impressive, at perhaps 3% to 4%. However meagre this might be, earnings growth will at least still provide a degree of support for equities, although the more powerful effect of lower interest rates and bond yields will likely have the greatest influence.
Across the equity markets, we favour the non-US regions, and particularly the emerging markets, which offer the three key attractions of a stronger growth profile, lower valuations and the potential for currency appreciation. While any deterioration in the re-energised US-China trade talks would be unhelpful, a more subdued US dollar (resulting from Federal Reserve rate cuts) could provide further support to emerging market asset prices.
“While we expect global corporate earnings growth to be positive in 2019, it is unlikely to be particularly impressive.”
Government bond yields have fallen to an extraordinarily low base again (many bonds now offer negative yields). From these levels, it is hard to envisage yields moving in any other direction but up. However, we expect any significant shift will be some time away given the disinflationary pressures that continue to plague advanced economies.
Within the broader fixed income asset class, we have maintained a strong preference towards US bonds, which we think are much more realistically priced than those in the Eurozone, Japanese or UK markets. This is primarily because the US offers much higher yields than other regions because the Federal Reserve has been raising interest rates over recent years. In respect to maturity, we continue to pursue a very short duration strategy focused on investment grade and high yielding corporate bonds (although we should note that credit risk has been reduced over recent quarters).
With the likelihood that the next British Prime Minister will be the pro-Brexit Boris Johnson, the chances of a “no deal hard Brexit” have risen. If that scenario was to transpire, we would expect the pound to come under further pressure. While there is much to play for, at this point in time we see more downside than upside risk in sterling. Over the quarter, this was recognised within client portfolios through the reduction of exposure to the pound.
Given that all asset classes have been quite strong in the first half, it would not be a surprise if there were to be a period of more subdued returns in the second half. In truth, it is quite hard to get excited about valuations these days, especially at the higher quality end of the fixed income asset class. At the same time, central bank policy will remain a very supportive force, which will continue to subdue volatility and drive investors towards equities and higher yielding assets.
Investments can go down as well as up to the level where your investments are worth less than when you originally invested. Exchange rate changes may also affect the value of investments. All data herein is sourced from local exchanges via Reuters, Bloomberg and other vendors. The information herein has been obtained from public sources believed to be reliable. All figures quoted were correct at the time of writing. Nedbank Private Wealth makes no representation as to the accuracy or completeness of such information. This information is for reference only and should not be taken as advice. Please speak to a member of the team or your private banker directly if you want to understand how investing with Nedbank Private Wealth can help you achieve your financial goals.
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