- Market volatility has returned, causing global markets to finish lower in 2018. We believe this end-of-year sell-off was overdone.
- Despite the correction, the global economy grew in 2018. We expect more of the same in 2019. We expect economic growth in China and the Eurozone to stabilize in the first half of 2019.
- All eyes are on the U.S. Federal Reserve. An early 2019 pause in increasing interest rates could allow the markets to refocus on fundamentals and deliver positive returns.
The tail end of 2018 was a rough ride for investors. Headlines, uncertainty about multiple geopolitical events and low liquidity all contributed to market volatility and a subsequent sell-off late in the fourth quarter of the year.
Volatility has returned to more normal levels and we expect it to continue. However, our outlook for 2019 remains positive, albeit with some clouds on the horizon that we are monitoring closely.
Adieu to 2018: Fourth quarter sell-off was overdone, but risks have risen
Although stocks sold off at the end of 2018, contributing to overall negative performance in equity markets for the year (S&P/TSX Composite Index -10.1%, S&P 500 Index -13.5%, MSCI EAFE Index -12.2%, in local currency terms), we believe this sell-off was overblown.
Here's a look at things that contributed to the performance:
- Financial conditions tightened and credit markets began to show signs of weakness.
- Low market liquidity and Fed interest rate policy uncertainty exacerbated the sell-off.
- Weaker Chinese and German data, protests in France and the U.S.-China trade dispute lowered investor confidence amidst market weakness.
Volatility has returned, which is normal
Recent market movements are a clear and undeniable sign that market volatility is returning to more normal levels following the unusually long period of calm we enjoyed in 2016 and 2017.
No matter what the cause is at any given time, we know that volatility, that is the tendency for returns to vary around their average, is a normal occurrence.
Rather than join those who buy and sell based on their emotional responses to short-term conditions and headlines, we treat recent market movements as a reminder to continue to manage our portfolios with discipline and remain properly diversified. We pay attention to those headlines and conditions so that you don't need to.
A look to the future: A global growth story
Despite rocky returns delivered late in 2018, we continue to think there are many good signs that global economic expansion should continue in the coming year. We expect to see positive earnings growth and continued strength in the global economy which should support stock markets.
Although economic growth will slow in 2019, our indicators point to global economic growth remaining positive this year, led by the U.S., with a low probability of recession. The U.S. economy will also slow in 2019, but again, economic growth will remain above potential. We will be watching for stabilization in a few key regions (China and the Eurozone in particular) during the first half of 2019.
We also expect earnings growth to slow down relative to the highs we saw in 2018, but we still expect it to remain robust globally, across countries and across sectors.
China's influence is of growing importance
Going forward, developments in China will be particularly important to the global economy. Lagged response to financial policy stimulus should be positive. (The country has introduced tax cuts, rate cuts and capital spending, and most recently injected US$83 billion into the country's financial system).
We are looking for signs that Chinese growth will stabilize in the first half of 2019. Improvement in China should also lead to improvement in the Eurozone, which underperformed growth expectations in 2018, mired by its own issues (Brexit uncertainty, French protests).
The U.S.-China trade dispute is another key risk that we are following closely. Indeed, signs of improvement in the Chinese economy or in U.S.-China trade relations could cause markets to rally in the coming year.
How we're positioned
Because we are optimistic about stocks, we've maintained our overall overweight position in equities relative to fixed income. We are now slightly overweight in developed market equities (Canadian, U.S., and international equities) but underweight in emerging market equities.
We are now in a neutral position in longer-term bonds and cash but underweight in short-term bonds. Bond mandates continue to play an important part in our portfolios as we use them to preserve investor capital.
As mentioned earlier, despite strong fundamentals—double digit earnings growth comes to mind—markets were weak and ultimately posted negative returns in 2018. We believe this leaves room for a meaningful rally in 2019 if conditions permit.
In particular, if the Fed holds steady and puts off future interest rate hikes as it has implied in recent policy interest rate announcements, we expect markets will refocus on fundamentals and deliver positive returns in 2019.
Another look at interest rates
Until very recently, it seemed that interest rates would continue to move higher. Now, however, it would appear that the Fed has achieved a tentative balance and will probably wait and see how the economy reacts. We think the Fed's rate hike cycle is nearly complete.
The rise of interest rates has been predominantly a North American story. Today we see that rates across the yield curve have stopped rising (some have fallen) which should have a less restrictive impact on growth. Both the U.S. Federal Reserve and the Bank of Canada have signaled that they will be increasingly data dependent when making their decisions going forward.
What does this mean for you?
Staying invested and sticking to your long-term investment plan is key to achieving success and reaching your long-term investment goals. Our outlook for 2019 remains positive, but we are watching risks very carefully. We are prepared for these economic conditions and trends.
It is true that risks have increased and short-term market performance has grabbed headlines, but rest assured that it won't change how we manage your funds and portfolios, which are designed to perform throughout the entire market cycle.
Working with your MD Advisor closely, our Investment Management and Strategy team positions MD funds and portfolios (this includes managing some funds directly and working with our sub-advisor partners) based on market conditions and signals, so we can achieve the best results for you.
As always, we will continue to monitor global conditions and make suitable adjustments to our strategy when appropriate.
If you have any questions about this outlook or about your portfolio, please contact your MD Advisor.
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