Never so good?

It is too early to make an assessment regarding 2018; however, there is very little chance for the year to leave a good memory for European investors.

Monthly Fund Commentary
13 Nov 2018

It is too early to make an assessment regarding 2018; however, there is very little chance for the year to leave a good memory for European investors.

In a recent study published by Merrill, only 23% of asset classes experienced a positive return, a figure so low, usually only occurring in times of a crisis. To have achieved a positive return for the year, a European portfolio “must” have held exposure to dollar assets and avoided significant diversification. 2018 has provided a stark contrast to the previous year during which (almost) all assets were rising calmly!

What to expect for the next few months?

The shock in October gives some answers: During the month, major indices were subject to a notable, at times “double digit” decline (-9.7% for the S&P 500, -12.9% for the Nikkei, -8.3% for the Eurostoxx). The sharp declines are thereby of the same magnitude as the fall experienced in February 2018. That said, the nature of the latest sell down appears quite different.

In both the United States and Europe these shocks have been accompanied by a marked change in leadership within the indices. In Europe, small and medium-sized stocks that have outperformed for several years are under significant selling pressure, while in the United States, rising technology stocks begin to underperform. These shifts in upward momentum in the indices are often a signal for profound changes in market behaviour. At the risk of killing the suspense, we do not think that 2019 will look like 2017, volatility and low returns will remain, with 2018 proceeding what may be a complicated 2019.

That said, we do not anticipate a hard landing of the economy. Should the bull market in the United States be “old”, with nominal growth at 5.5% and 10-year rates at around 3.25%, there is no reason that the well-oiled machine should stop during the next few months. From this point of view the stock market environment is not that negative, with statistics also being favourable for investors: since the war, the American markets have always offered positive returns during the 12 months following the mid-terms!

“Policy changes implemented by the large central banks have begun to produce effects that are far from exhausted.”

Our caution therefore does not reflect a fear of a forthcoming recession; but rather is a conviction of a continuation of the “repricing” of large classes of assets. Policy changes implemented by the large central banks have begun to produce effects that are far from exhausted. Adding the following, 1) the underlying trend of the Sino-US trade dispute, 2) Brexit-related fears (the clock is now ticking) and 3) the skirmishes between the US President and the Fed, various occasions for sell-offs are likely to arise.

Investors commonly attempt to rationalise market movements by reflecting on macroeconomic developments, with “the market going down because Trump threatens China and Germany” or going up “because an agreement was found”. The impact of such rationalisation is the reality that the markets have their own dynamics which are commonly overlooked.

As such, a macroeconomic development may not have the same impact on the market should it reoccur in a different context. Long protected by the central banks’ net, the resilience of the markets has been exceptional. The change that has begun over the last few months does not so much reflect a brutal darkening of the economic outlook, but rather shows a greater fragility of markets now prone to sharp adjustments.

It will be necessary to resist the excessive pessimism associated with market declines and the over-enthusiasm during periods of recovery and to remember the closing sentence of the novel Une Vie de Maupassant; “Life, after all, is not as good or as bad as we believe it to be”, just like markets …

 

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