EquitiesJan 9 2019

What will 2019 bring for markets?

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What will 2019 bring for markets?

It is no wonder 2018 has been a poor year for UK equities, with the ongoing shambles of the Brexit negotiations and the internecine warfare in the Conservative Party about the UK’s departure from the EU. Debate still rages in Westminster over Brexit.

Meanwhile, in the markets, after a great 2017 with global synchronised growth, 2018 was expected to produce more of the same and there was another leg of the bull market.

In the US, President Donald Trump’s tax cuts propelled the US economy into the stratosphere and the S&P to record highs, driven in part by insatiable demand for technology and the so-called Faangs – Facebook, Apple, Amazon, Netflix and Google.

However, the strength of the US economy in the second half of 2018 caused all manner of problems, especially for emerging markets as rates and the dollar rose.

The Federal Reserve seems to be getting much of the blame for the woes of the past quarter. But in its defence, the central bank said all along it would raise interest rates four times in 2018, which indeed it has done. So why did the market wake up in October and panic?

As I write (December 13 2018), most major markets are down in 2018: with the S&P 500 dipping 0.09 per cent, the Dax 30 falling 16.54 per cent and the FTSE dropping 7.77 per cent.

You will hear this from most people in the next few weeks, but 2019 will be determined by three key things: Brexit, US interest rates, and US/China relations. 

Of most importance to global markets will be the actions of the Fed. Two rate rises seem likely in 2019, though there may be more if wages rise sharply, in which case you will want to avoid emerging markets. 

US/China relations have thawed slightly, with further tariff hikes postponed for three months – a good outcome to these talks could propel Asian equities this year. Indeed, any perceived positive news is enough to move markets currently. 

Key points 

• Most major markets were down at the end of 2018.

• UK stocks are cheap.

• A hard Brexit will lead to a sharply falling currency.

 

Currency is another area to watch out for in 2019, but the previous three points will influence what happens in the foreign exchange markets.

This year could see some big currency swings as markets digest ongoing news flow around Brexit, interest rates and China.

UK markets

One of the most fascinating facts of 2018 is that overseas companies were happy to buy out British businesses – Sky and Shire are two recent  examples, but global fund managers will not invest here. This leads me to believe there is good long-term value to be found in the UK as otherwise business would not invest.

The UK on many measures looks cheap. The market sits around its 40-year price/earnings ratio average of about 14 times earnings, but that masks companies with dollar earnings on much higher ratings and domestically focused companies on single-figure P/E ratios. 

The graph shows the 10-year gilt yield against the UK dividend yield.

 The difference between the two is one of the widest for many years. Are gilts expensive and shares cheap?

Brexit

It is reasonably simple to position for Brexit. However, the outcomes are binary. A good soft Brexit will lead to a strengthening currency and a mild stock market bounce – led by domestically focused stocks.

A hard Brexit will lead to a sharply falling currency and probably a stock market drop, though I do not think the dollar earners will save the FTSE this time. A soft Brexit is still the most likely outcome – despite parliamentary shenanigans – and therefore you want sterling assets and more domestically focused companies. 

If hard Brexit is the outcome you do not want UK investments, and you want to avoid sterling. In that scenario any non-UK equities (or fixed interest) are what you want. So go global, but avoid Europe.

Global markets

There are not too many positives to look at in 2019 with growth slowing and populism rising – neither are good for markets. The US will continue to see good earnings growth, but probably half as much growth in 2019 as occurred in 2018.

Europe looks like it is stagnating, especially if there is a messy Brexit. As ever it is Asia, emerging markets and Japan that look interesting, both from a price perspective and a growth outlook – many markets are on multi-year lows. 

Recent falls do create value though, and probably make equities a more enticing bet than at the start of 2018.

Bonds

It is hard to get excited about the outlook for fixed interest in 2019. The US has some attractive yields on offer, yet by the time that has been hedged back to sterling most of this excess return has gone. 

As with equities, emerging markets look the most interesting opportunity after large falls in 2018. However, it is a gamble investing now while the path of US interest rates is upwards and a dollar squeeze is ongoing. But if you can live with the volatility today, it is probably worth opening a position, as timing the bottom is impossible without a huge amount of luck.

Property

Similar to bonds, commercial property also looks fairly anaemic. Coupon clipping is the most likely outcome for 2019, and if there is a Brexit shock then values could fall sharply and physical property funds may run into liquidity issues.

There are some bright spots in the market, but high street retail is not one of them and the problem with the bright spots is they look expensive.

The next few months will provide some nervous moments, but the key is to ride these out. Many equities look decent value for such a late point in the economic cycle and lots of bad news is priced in.

Buying selectively could yield good long-term returns.

Ben Yearsley is director of Shore Financial Planning