The recent inverted US yield curve sent investors into a frenzy, with many prepping for the doomsday that could follow. But, while some investors might be running to sell off their assets, the experts think fears are probably overdone, and that a long-term investment horizon might just see you through this year’s expected volatility.
Looking back on the last 12 months, political upheaval, economic volatility and tariff threats and implementations have turned global stock markets upside down, with 2018 ending with a pop rather than a bang.
The US/China trade war (or rather, trade spat) saw fears grow over the rate of slowdown in those respective economies at a time when the US Federal Reserve’s (Fed’s) rate hike cycle was also leading to an increased risk of recession.
But, according to Zehrid Osmani, Legg Mason Martin Currie portfolio manager, the first three months of 2019 have seen a significant bounce back in response to lower valuations, a more dovish Fed and some progress in trade discussions between the US and China.
What’s more, according to Legg Mason QS Investors portfolio manager, Michael LaBella, the MSCI World Index was up over four per cent over the last 12 months, and over 12 per cent for the first quarter of 2019, making it the strongest quarter since 2009.
So, where are we now?
Despite a strong Q1, the inverted US yield curve has still had investors spooked, and the experts think global growth is looking a little sluggish.
So, given we are already in the later stages of what has been, according to Osmani, the longest growth cycle in history, there is a growing risk that a recession could be coming at some point in the next two to three years.
But, instead of focusing on the risks, Osmani said it’s more relevant to reflect on and assess whether the recession would be deep or shallow, or how prolonged it would be.
“If we are faced with a shallow and short-lived recession, we think this would give a great opportunity for long-term investors to get involved in the asset class again at attractive levels,” he said.
“We are therefore inclined to invest on a counter-cyclical basis.”
LaBella even said the global outlook was broadly supportive of global growth, and while the inversion of the yield curve has been a reliable predictor of recessions in the past, it did not mean a recession was imminent.
“The yield curve is signalling to the market that we are in the latter stages of the business cycle; however that does not mean the immediate end of this cycle,” he said.
Wealth Within’s chief analyst, Dale Gillham, also suggested that with the bullish outlook on world markets, he did not believe investors needed to worry as there was still good value in stocks over the medium term.
“There is a strong focus on the state of the US economy at the moment, however, history indicates that an inverted yield curve does not always lead to a recession,” he said. “There are positive indicators for growth and some economists suggest it would be a mistake to just focus on the yield curve.”
Nonetheless, the Legg Mason affiliate managers urged investors to diversify and be highly selective when it comes to stocks.
“I believe taking a highly selective, stock-focused and long-horizon approach based on in-depth fundamental analysis of companies will help to mitigate the risk of getting wrong-footed by market volatility,” Osmani said. “It will provide great opportunities to invest in businesses exposed to some compelling long-term growth themes, that have pricing power and strong balance sheets, at attractive valuations.”
LaBella suggested that, rather than overreacting to the possibility of a recession or an inevitable slowdown, investors would benefit from looking closely at their portfolios to ensure they are adequately diversified across asset classes as well as within underlying asset classes.
“One of the effects of the bull market over the last decade has been a growing concentration of technology and cyclically oriented companies within market cap weighted indexes as a result of their relative outperformance,” he said. “So now is the time for investors to ensure their portfolios are adequately diversified across regions, styles and sectors.”
EMs and the EU
Fidelity’s Global Equities fund portfolio manager, Amit Lodha, said the two major headwinds from last year, the US/China trade war and Brexit, have continued to weigh on investor sentiment.
As 2018 progressed, Lodha said global equities, especially emerging market equities, bore the brunt of investors’ concerns about the state of the Chinese economy.
“Although, the recent alleviation of trade tensions given the ongoing dialogue between China and the US is a welcome sign; this uncertainty lasting for longer could become a drag for investment and would be very negative for investors,” he said.
Despite concerns, Lodha said Fidelity found opportunities to add exposure into quality businesses in the region. The portfolio manager said following the 2018 sell-off, EM equities, particularly in the Chinese market, were attractively valued, with continued scope for re-rating despite a strong start to 2019. And, while US dollar strength had been a significant headwind for the asset class, more recently, markets breathed a sigh of relief as the US Federal Reserve paused interest rate hikes this year.
“From a long-term perspective, emerging markets continue to offer many interesting bottom-up investment opportunities, supported by structural growth drivers,” he said.
Lodha also noted the EU did not look so favourable though, and European equity markets were set to face some challenges given the continuing uncertainty surrounding Brexit and, of course, trade concerns between the US and its trading partners, which could negatively impact the eurozone’s export-led economy. But it’s not all doom and gloom, and once the cloud-cover clears on Brexit,
Lodha said markets could rise again.
“In the short term, Brexit may cause greater than usual volatility in UK economic data over the coming months. However, once clarity emerges on future trading agreements with the EU, we may see a pick-up in economic activity,” he said.
Get strict on stocks
Given the expected volatility, industry experts said getting strict on stocks was the best way to stay grounded, and to Martin Currie’s Osmani, this meant integrating environmental, social and governance analysis in the investment process.
Osmani said this enabled investors to have greater oversight of the various risks that could impact the future economic value of companies. So, when situations like the trade war arise, given the managers are long-term investors and highly stock-specific, they’re not positioned to respond, but rather to take advantage of attractive entry points.
In the last 12 months, the Martin Currie Global Long-Term Unconstrained Fund’s best performing stock was the US tech stock, Automatic Data Processing. Osmani said the stock was a leader in human capital management, had stable revenue growth and expanding returns, and after some minor hiccups, it was now posting solid numbers.
Whilst they’re generally bottom-up stock pickers, Osmani said it would be unlikely that the fund invested in mining, energy, telecoms, utilities or banks.
LaBella’s quant-style QS Investors Global Equity fund likewise is focused on stock selection rather than trying to time country or sector exposure, so when it came to the US/China trade war and
Brexit, the portfolio wouldn’t change unless data inputs to the stock model change.
What does 2019 have in store for global investments?
Lodha predicted that while a number of factors point to positive moves in the global equities market, overall, caution is still warranted towards risk assets in the current late-cycle environment. He was positive on oil given supply was being curtailed as a result of production cuts from Venezuela and Iran.
As well, China seemed intent on reflating, and the country’s property sector looked like their tool of choice. While Lodha was unclear on how much the country would be able to achieve given longer-term structural issues remained, he said China seemed to be stabilising.
In terms of inflation, Lodha said recent remarks by Fed chairman, Jerome Powell, suggested the Fed had gone dovish in a bid to drive inflation higher, so the portfolio manager urged investors to find companies that could price ahead of inflation.
“Underlying fundamentals have not improved along with the rebound in markets, as risks in the global economy persist,” he said. “The hard-economic data is yet to catch up with the recent green shoots in some areas of economic activity. Decelerating below-trend global growth and weakening earnings outlook for 2019 remain areas of concern.”
Despite the rough waters ahead, Lodha said the rising number of “Unicorn IPOs”, like Lyft and Uber, was a sign of some “froth building up”, which he believed should give investors a pause for thought.