New year, new markets?

Mid-January is the time when many start to dither on new year’s resolutions and fall back into bad habits. After a decent start to the year, markets could easily follow suit: with plenty of problems unresolved, there’s no guarantee 2018's turbulence won't return. 

For now, a self-correcting mechanism is at work. Putting aside a more dovish Fed, part of the reason for the bright start may be that sharp sell-offs tend to create more bargains.

But how do wealth firms feel about such prospects? Having run the rule over analysts' outlooks at the end of last year, today we're turning our attention to discretionaries themselves. We've combed investment commentaries to take a sample of DFM sentiment at the turn of 2019.

What’s immediately evident is that none are pulling punches about the severity of recent volatility. At the same time, most retain a degree of stoic optimism about the year ahead. And it’s unlikely these opinions are being voiced just to reassure clients - if managing the message were the priority,  steeling investors for a year of lower returns might be a more sensible strategy.

But as we've frequently noted, consensus views are harder to come by at the moment. Our sentiment analysis reflects that: roughly half of wealth managers strike a note of optimism for the year ahead, but 15 per cent are neutral and a third on the gloomier side.

So while all can agree on the unresolved problems of 2018, from trade wars to Brexit, different firms point to different bright spots. These range from emerging markets – which had a better December sell-off than some wealth managers expected – to alternatives and US equities. Sarasin, for instance, retains its faith in “carefully selected equities", ie those capitalising on global trends, to drive returns.

Next week we’ll be taking a closer look at how DFMs reacted to the closing quarter of 2018 from both an asset allocation and fund selection perspective. For now, we should note that not a single firm thinks fears of a US recession look justified for this year. The wider market seems to have formed the same conclusion in the past couple of weeks.

Woodford hopes for a reset

A fresh start is exactly what was needed for some fund managers come January. One obvious example is Neil Woodford, who ended 2018 down some 16.5 per cent for the year.

As previously discussed, most DFMs have long since abandoned their holdings in the manager’s flagship fund. Three consecutive calendar years of underperformance tends to be too much to tolerate, particularly when the second and third come with the kind of high-profile blow-ups suffered by Woodford Equity Income.

That said, a contrarian might think the fresh start had already begun in the second half of last year: Mr Woodford’s relative performance began to improve around that point, though he was far too far behind the pack for it to make much difference to the year as a whole.

Notably, this pick-up came at a time when wider markets were struggling. Despite his fund being loaded up with biotech positions, the manager’s assertion that he’d perform better when market “euphoria” disappeared seems to have been accurate.

At the same time, there’s still one big part of the portfolio that is dependent on better economic outcomes. Mr Woodford’s bet on UK domestic stocks is reliant on the worst case Brexit scenario being avoided: yesterday's housebuilder rally, tied to the growing speculation over an extension to Article 50, confirms that.

The blow-ups haven’t gone away yet - discussing potential positives feels a little reckless just three days after Provident Financial, still a top five position, slumped another 20 per cent. And wealth managers are hardly likely to dive back in so soon after shifting away. But the portfolio’s quasi-defensive qualities might be worth keeping half an eye on in the meantime.

Policy preconceptions

Picking up another theme raised in our first story, we’ll end the week with a brief thought on the Federal Reserve’s policy positions. Not the rate-hike backpedalling of recent weeks - which, while welcome, was perhaps a little embarrassing for the central bank - but the overarching policy of quantitative tightening.

Jerome Powell’s comment that the QT programme was "on autopilot” was widely seen as helping trigger December’s sell-off. The choice of words was unfortunate, given it implied the Fed would disregard external events in the meantime. Mr Powell has since followed his predecessors by indicating he remains conscious of the need to take into account investment market movements. 

The whole episode should prompt asset allocators to take a more benign view of QT as a whole: it emphasises that reducing the size of the Fed’s balance sheet doesn’t automatically mean bond yields are going to go up, or vice versa.

The autopilot comments caused a stock market sell-off and pushed yields lower, whereas the commitment to a slower pace of selling from the Fed boosted confidence and helped yields tick back up. So while rate rises retain their ability to scare investors, quantitative tightening commitments shouldn’t automatically be viewed as a negative - for fixed income positions, at least.