- I analyze three lessons learned from 2018, a tough year for navigating markets due to rising rates, trade frictions, and unexpected turns.
- Weak economic data led to increased growth slowdown fears resulting in equity losses. The UK’s prime minister Theresa May won a confidence vote from her party.
- The Federal Reserve will likely raise rates sometime this week and will be under scrutiny for indications about a probable cause and its future path.
2018 has been a difficult year for navigating markets. Many equities, credit, and bond markets around the world finished the year with losses. Higher interest rates and trade uncertainty has pulled stocks down and offset strong earnings growth. What’s the lesson, the first of three we can learn from 2018? It’s that geopolitics do matter.
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Earlier, there was a possibility that markets could face temporary setbacks in 2018 if the U.S. tough trade talk was implemented. Yet how much geopolitics has impacted markets has amazed even us. The impact on stocks can be seen clearly from the decrease in valuations in the chart above. This decline corresponds with increased attention to the potential danger of trade tensions throughout the year and concern about geopolitical risks reaching unprecedented levels. This is evident from this geopolitical risk indicator. Besides the US-China trade relationship, other more local geopolitical risks have impacted European markets and many emerging markets (EM).
1. Adjusting to rising rates and developing portfolio resilience
It is evident that trade frictions are more woven into asset prices than was the case a year ago. Yet we expect the unpredictability the U.S. trade policy to negatively impact online trading markets. The risk of fragmentation in Europe is another geopolitical risk that gives a concern. Overall, we’ll likely see more market sensitivity to these geopolitical risks in 2019 as global growth weakens: Geopolitical shocks tend to impact global markets more acutely and for longer when the economy is waning.
2. Cash has become a practical alternative to unsafe assets for U.S.-dollar funded investors as a result of growing short-term yields
Markets with poor fundamentals have also been exposed. Two-year U.S Treasury yields have tripled after the crisis period. Emerging markets assets were also hit much harder than I had expected by rising rates. This resulted in a wide dispersion in returns for EM. Many EM assets are currently offering higher compensation for risk moving into 2019, and the Fed will likely pause its quarterly hikes due to contained inflation and slowing growth. EM countries that have big external liabilities, however, will likely face more intense Fed tightening.
3. Develop toughness portfolio: markets drawdown due to rising volatility
A number of market segments have nose-dived. Financial stocks, cryptocurrencies, and even perceived safe-havens like telecom stocks are among them. It is reasonable to asset that 2019 will bring sharp price hikes that are not linked to fundamentals. The barbell approach will also have place. On one hand, exposures to government debt as a portfolio cushion and allocations to assets that offer attractive risk compensation. On the other hand, return prospects such as EM and quality stocks. That means, it will be essential to stay away from assets with poor returns if things go right, but follow huge downside if they don’t. European sovereign bonds and European equities will likely fall into this category.
Review of Past Months:
- Global stock markets fell due to slowdown fears from poor economic data. Trade friction concerns and politics in Europe also compounded the uncertainty. China's industrial production and November sales were also lower than expected. U.S. retail sales, however, beat analysts expectations.
- Theresa May came out on top in a leadership tussle in Britain's Conservative Party. However, she failed to secure concessions from the European Union that would have made it more probable for Parliament to pass her agreement proposal for Brexit withdrawal. Also, the Pound was unstable.
- The Italian government bond yield dropped due to a meaningful reduction in the Italian budget deficit. This may still not be able to prevent the European Council from carrying out the”excessive deficit procedure”. The Central Bank of Europe also confirmed that it will stop buying net assets in December. It will proceed with reinvesting until a rate hike.