Looking back at 2018
Coming off a strong 2017, developed markets outside the US were basking in the glory of over 25% in added value since the start of the year, supported by ever-mounting optimism from global investors. The first few weeks of 2018 appeared to be a continuation of the upward trajectory, with pundits touting tax reform in the US and positive corporate earnings as a major source of support for an already strong bull market. Meanwhile, many critics and volatility specialists were raising alarm bells about a market that appeared overvalued and overheated – and a volatility profile that had remained exceptionally low for too long.
After 25 days and over 6% in gains across developed market equities, the party was over and the easy money vanished. The February decline was likely the result of a confluence of factors – including over-valuation, rising interest rates, tightening monetary policies and geopolitical concerns. The result was a year more akin to downhill skiing, with developed markets erasing most of the gains made in 2017 and returning to levels last seen in March of that year.
Self-assessment: Forecast scorecard
In our 2018 outlook, we were quick to warn that it was tempting to feel complacent about the market given strong results and muted day-to-day price swings in 2017, but that the new year also carried a sense of uneasiness for investors worldwide that should not be ignored. At Seeyond, we believed the situation was very unusual. Low volatility is typically a sign of consensus over the path of the world economy, which we didn’t believe was the case entering 2018. “Beware of volatility spikes in 2018,” we wrote, while cautioning against “the temptation to try and time such volatility.”
State of the current market
Earnings growth has been strong over the period, which benefited mostly growth stocks. Increasing growth expectations are not typically conducive of outperformance in low volatility stocks. With the MSCI EAFE index posting negative returns so far this year, the animal spirits observed in equity markets in 2018 have arguably cooled down – which has the potential to result in outperformance among low volatility stocks.
In parallel, rising interest rates, trade tensions, high valuations and pressure on corporate margins have led investors to look beyond the immediate strong earnings and growth dynamic, which brought volatility back to more normal levels. This has also helped outperformance in low volatility stocks. Lastly, increased dispersion in returns (at stock, sector, and country levels) has been present in the equity market over the period – which is a source of opportunity for active managers.
Looking forward to 2019
Despite strong economic readings, growth expectations continue to point towards a positive but low growth environment.
- The US Fed continues to anticipate a 3.0% long-term level for interest rates in the US, not pointing towards high growth or high inflation.
- Some early signs of peaking growth are emerging in international trade and European growth figures. Current growth readings and expectations remain robust, and consensus points towards a low likelihood of recession in the short term.
- While we agree that the next recession is likely closer than the previous one, we would again caution against the temptation to time a potential spike in volatility.
Seeyond believes that interest rates, trade tension, high valuations and pressure on corporate margins will continue to push investors to look beyond the immediate strong earnings and growth dynamic. Associated volatility and uncertainty will likely continue to create anxiety in the marketplace. We believe investors should avoid putting themselves at the mercy of emotionally driven investment decisions which can adversely impact their long-term financial plans.
While further bouts of typical end-of-cycle bull bucking cannot be excluded, our core scenario continues to point towards low growth and higher volatility. We believe now is the time to complement portfolios with strategies specifically designed to help investors become less dependent on day-to-day gyrations in equity markets.
CFA® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.