We’ve certainly had a strong start to 2019 in terms of performance in equity markets. This has been very different to the end of 2018, where we saw a significant sell-off over the last quarter of the year.
Our view is the increased level of market volatility late last year was caused by commentary from the US Federal Reserve. After they increased rates in September, the Federal Reserve indicated that rates rises were going to be at a faster pace through 2019 given the ongoing strength of the US economy, and that cash rates remained a fair distance from ‘neutral’. This spooked financial markets with investors fearing that cash rates would move higher and potentially at a quicker pace through 2019, which would be negative for equity markets. So, the resulting impact of the ‘messaging’ from the Fed was a significant broad based sell-off in equities, but most notbaly high-risk equity asset classes such emerging markets and global small caps.
However, at the end of 2018, the Federal Reserve reversed their position and indicated that we were only likely to see a moderate level of rate rises through 2019, and that the Fed was indeed ‘closer’ to the neutral rate than previously indicated. Whether the extent of the decline in equity markets precipitated this view is debatable, but we always felt that four rate rises in 2018, would afford the Fed greater flexibility in 2019. However, the comment provided the necessary backstop to the market’s slide and has again given investors more confidence to invest benefiting both the equity and fixed income markets.
From our perspective, we’re still a little cautious on the direction of financial markets near term. We believe that volatility will be here for a while as the market works through four major issues:
- US rate rises – It is highly likely we will continue to see rate rises in the US, although we don’t expect any moves until the second half of 2019;
- Brexit – The uncertainty around Brexit remains and is impacting on both consumer and business conficend. In addition, we are seeing a clear slowdown in European growth, which is a challenge for policy makers given that cash rates are already at zero (and negative in some instances);
- US-China trade negotiations – These discussions continue to be front and centre. This will continue to impact the growth outlook for emerging markets in particular and has the potential to further disrupt global growth and the outlook for corporate earnings; and finally,
- China growth – The growth in China has moderated through the second half of last year. We think the Chinese government and the central bank will continue to do more to ensure that growth maintains a healthy balance, but it’s something to watch when thinking about the overall level of growth across emerging markets.
In addition to the global macro outlook, on the domestic front, house prices continue to move lower, while debt levels remain high. While there are calls for the Reserve Bank of Australia to cut rates, our current view is they’ll maintain a steady rate policy given that cash rates are already at a historical low and could be viewed as being at an ‘emergency level’. While the employment market remains sound (despite the lack of wage growth), we see no reason or rationale for the RBA to move.
These factors all feed into our thought process when considering overall asset allocation. While we haven’t made any significant changes to our portfolios, we continue to balance our allocation across both defensive as well as growth assets. And while we have increased our position to defensive assets (such as fixed income), we have maintained a slight skew towards equities given the potential for greater upside in equities over the medium term and (based on current data) we don’t believe a recessionary environment is likely.
As always, if you have any concerns about your portfolio or asset allocation please feel free to reach out to your financial adviser.
Piers Bolger is Chief Investment Officer at Viridian Advisory