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Outlook 2019: Back to reality

2018 has been a challenging year for investors. After the stellar investment returns of 2017, perhaps it was always likely to feel this way. A shift in the economic environment gave way to a more difficult scenario where a series of volatility waves damaged asset class returns.
29 November 2018
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    Outlook 2019: Back to reality

    By Zoë Constantinou

    2018 has been a challenging year for investors. After the stellar investment returns of 2017, perhaps it was always likely to feel this way. A shift in the economic environment gave way to a more difficult scenario where a series of volatility waves damaged asset class returns.

    In fact, of the main asset classes, only US equities and the US dollar have recorded meaningful gains in 2018. Other asset classes are either flat or have delivered negative returns. For a multi-asset investor, the situation was made more difficult by the poor performance of traditional diversifiers. For example, US treasuries have delivered negative returns overall and sold off alongside equities during the market episodes of February and October (see Figure 1). The typical sources of portfolio protection haven’t worked in 2018.

    Figure 1: US bonds have not been a diversifier

     

    Source: Bloomberg, HSBC Global Asset Management, November 2018. Investment involves risks. Past performance is not indicative of future performance.

    The journey: key macro events

    Much of what has happened in 2018 is linked to changes in the economic environment and market expectations. These are reflected in the two key macro events of 2018: i) a re-pricing of US rates and ii) a dollar rally.

    The central economic theme for the year has been “cyclical divergence”. After the phase of synchronised global growth in 2017, this year has seen US economic leadership versus the rest of the world. This strength in US growth – and policy tightening from the Fed – has forced the market to significantly re-assess its view of the interest rate cycle. US 2-year bond yields are now over 100bp higher than they were 12 months ago. This shift, plus the apparent growth weakness in the rest of the world, has created significant pressure for the dollar to appreciate. In Q2, we experienced a “dollar shock”, especially for emerging market investors.

    For emerging markets, the combination of a shift in sentiment due to trade tensions, cyclical divergence, an aggressive US dollar rally, and in some cases, homemade problems, created macro risks. Emerging markets effectively entered “doom loop”, a vicious cycle of falling asset prices and worsening fundamentals.

    The journey: risk environment

    This year’s episodic volatility may feel abrupt and extreme, however it is just a more typical market environment. 2017 was the anomaly, not 2018 (Figure 2). We are now moving “back to reality”. But, compared to the past, what has felt trickier is the fact that so-called “safe havens” have not provided downside protection.

    Figure 2: Global equity volatility is still below the historical average

     

    Source: Bloomberg, HSBC Global Asset Management, November 2018. Investment involves risks. Past performance is not indicative of future performance.

    But it’s not all bad news…

    To avoid the anxiety created in 2018, we need to take a step back and put this recent experience in context. The last 10 years have been outstanding, global equity excess returns have been at over 9 per cent per year and global credits at over 5 per cent. And whilst it may be unlikely to see these kinds of outsized returns consistently going forward, we are still in a place where fundamentals look good (Figure 3). This year alone, we have seen earnings growth of over 15 per cent in developed and over 7 per cent in emerging markets. The environment is not as bad as the market is making it out to be, which brings us to an interesting juncture for asset allocation.

    Figure 3: Global equity earnings have held up

     

    Source: Bloomberg, HSBC Global Asset Management, November 2018. Investment involves risks. Past performance is not indicative of future performance.

    What next?

    Stay tuned for the next instalment of the Outlook series, where our experts explore the macro overview and key investment themes for 2019.

    The views expressed herein do not constitute investment advice, research or trade recommendation. Such views are the personal views of the author only and do not necessarily represent the views of HSBC Global Asset Management (Hong Kong) Limited.