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2018 Markets Review

2018 Markets Review

2018 summary & 2019 predictions

I am writing to you during our office move. Workers are all around busy packing and unpacking boxes. We have been in our old building for 10 years. At the time we moved in there, the S&P was about 880 points and the Dow Jones was about 8300 points. Since then they have gone up by 242% and 244% respectively. Even after a tough year and pretty awful 4th quarter, the long-term gains are impressive. It may appear as though it was easy to make money however; there were plenty of reasons to be concerned along the way. When we said to clients over the years "focus on the long term", so far, we have been right.

As I tidied my office for the move I found a collection of year-end predictions for years gone by written by some of the highest paid experts in the world. Some were right some of the time; many were wrong most of the time… Some were right in the longer term and very wrong in the short term. It seems no one has the perfect crystal ball. 2018 rollercoaster has been no different but more on that below.

We look forward to hosting you in our new offices at the Amzur building.

2018 Summery: A difficult year for all liquid asset classes

Index name / Asset

2018 performance

MSCI AC – World Equity

-9.42%

Barclays Aggregate Global Bond

-1.20%

Chinese Equity

-18.8%

Gold

-1.56%

S&P 500 – American Equity

-4.38%

Long duration USA Government Bonds (TLT)

-1.61%

Emerging Market General Equity

-14.56%

Emerging Market USD Bonds

-5.52%

European Equity in USD (Eurostoxx 50)

-15.55%

Late December headlines read: “Trillions wiped out”, “worst week in a decade”, “worst quarter since 2008” and so on... Unfortunately, investors all over the world are likely to feel disappointed with their portfolio results. Many will question their asset managers and their approach and some self-managed investors will pay a painful price for lack of diversification. My main message to readers here is that we have been here before. More recently in 2015–2016 and before that in 2011 and many times before that – this is the market doing what a market does... We need to remember the market does not work in rational straight upward pointing lines. The second main message is that it is not the time to be selling; it is the time to be buying. 

For those of you who have many years experience of watching portfolios in up and down markets, you will remember a few of the bad years. 2011 was the last bad year and that was soon after the disastrous 2008. 2018 will be remembered for a few anomalies. It needs to be stated that 2018 was, in a way, even more difficult than 2008. In 2008, the main equity indexes were worse in absolute terms, no doubt; however certain asset classes like government bonds did make money, in a classic “flight to quality”. Asset allocation did not work perfectly in 2008 as correlations increased across asset classes, but at least we had some assets (e.g. government bonds) making money to dampen the losses. 2018 was the first year since 1969 that both the S&P 500 equity index and the 10-year USD bond (the main government bond reference) were negative. In 2008 this bond index was positive. This type of scenario makes asset allocation extremely difficult. Taking a more global view and looking at the MSCI and the global bond indexes, 2018 was the second time since 1991 that both of these were negative. Again, an extremely difficult environment for asset allocation. However, the good news is that most other strategies did far worse than an asset allocation based strategy in the last quarter of 2018. Stock pickers who were criticizing our longer bond and emerging market exposure in the first 9 months had their relative advantage completely wiped out plus more in the fourth quarter. December investment reports are going to make interesting reading for many.

The questions on our minds are firstly, is the equity market sell off the beginning of a protracted bear market, as a precursor to a recession? And secondly, was 2018 an exceptional year or, as some commentators have been predicting, asset class correlations have broken down due to extended periods of low interest rates? The first question is more difficult to answer, however it seems that the evidence is showing that it is not the start of a protracted bear market and as for the second question, we still believe correlations are relevant.

Stock / Asset

YTD Performance

12 month peak to trough

Apple

-5.39%

-36.73%

Facebook

-25.72%

-42.96%

Amazon

28.43%

-34.10%

British Am Tobacco

-47.17%

-51.70%

General Electric

-55.39%

-64.72%

Anheuser Busch

-38.84%

-40.50%

Bitcoin

-74.30%

-81.16%

Cannabis Index

-18.80%

-45.64%

AXA Floating rate perp

-3.78%

-18.20%

Whilst US economic growth numbers and corporate profits are still strong, it is “late cycle” and markets do work in cycles. The US stock market rode a rollercoaster ride in 2018 that will not be forgotten quickly by those who were caught in it. The difference between 2018 full year and 2018 peak-to-trough numbers is staggering (see table). For example if you held Apple for the full year you only lost 5.4% but if you bought it at the peak you lost 36%. The following table highlights some of these anomalies and means. Investors who invested through the summer are most vulnerable.

2019 Predictions

Economic view

The USA economy grew by over 3% in 2018. This is unsustainably high and we expect that to slow down, however we do not expect a full recession. It would seem that the 4th quarter sell off is “over done” compared to the economic outlook. In other words, the market is pricing in worse news than seems likely. After many years of saying the US market is expensive it is now trading at a forward price earnings of 15.4 which, whilst not cheap is not excessively expensive. This re-enforces our optimism for 2019.

A lot of attention lately has been given to yield curve dynamics. This is a very technical discussion however; it has made its way into general conversations. Basically, a yield curve inversion is when longer term bonds pay less than shorter term bonds and when this happens it has been claimed to precede a recession. Currently, we have a mainly upward sloping yield curve with only the 5-year and 3-year showing a very tiny inversion. This is not material in our opinion. It should also be noted that the same research that says an inversion precedes a recession also stated that the market would peak at least 20% higher after the inversion. Again this should be an optimistic signal not a negative one, at this point.

Political view

In 2018 we experienced some major political issues: Iran oil sanctions revisited, Italian budget issues, China trade wars, US mid-term elections, etc. Iran and Italy issues have currently abated and the trade war rhetoric has decreased.

Political issues in 2019 will continue to test market resilience, especially as it relates to the European question notably Brexit, but also continued pressure on the weaker economies of Europe. Italy, even though it reached a deal with Brussels, is the most concerning of the European weaker economies because of its size. My personal view on Brexit is that it is hard to imagine that the conservatives will “dive on the proverbial grenade” and commit political suicide by allowing a no-deal Brexit to happen. Economic chaos may ensue, some industries will have perceived difficulties and in some industries it will be real. E.g. certain parts of Financials Services such as banking services from London to Europe, may not know how to work without common regulation. This will lead to a general election and a most likely Labor victory. It is difficult to imagine the conservatives handing over power like that. On the other hand, it seems impossible to me that Theresa May will succeed in getting a deal through government in January. I therefore feel that some sort of last minute delay is probable, with perhaps, even a reversal, of Brexit. I pity investors who have significant GBP exposure because it is not an easy decision to hold on to it. A disorganized forced Brexit and Labor victory is going to be painful for GBP investors. If Britain cannot leave, no one can leave and this will be a strong re-enforcement for the Euro, as it will provide stability. If Britain does somehow manage to leave, then it will be a big step in the wrong direction for the EU. With such a binary result, it is difficult to make portfolio decisions.

As for the trade war talk, which hurt our exposure to Emerging markets, we expect it to continue at a lower intensity. The trade imbalance between China and USA and the resulting geopolitical forces is a dynamic that has been around for 20+ years and will only continue.

During 2019, elections will take place in a few countries like Israel, South Africa, and Greece; however the one to watch is the European Parliament elections in late May. This will indicate if the more socialist elements in Europe are gaining or losing strength.

Market view

Normally after a negative year, we do see some sort of rebound, so based purely on this I am somewhat optimistic for 2019, especially since the technical data favors a more encouraging risk/return outlook. Therefore, we are predicting a moderately positive bounce back in the equity market. We do expect the 10-year USA treasury to finish 2019 closer to 3.5% than the current 2.68%. This will put longer-term bonds under a little pressure. We believe that the Emerging markets, notably China, have been oversold and hope to make money there. Strategically, this needs to be part of a portfolio for long-term growth.

The USD has been strong in 2018 and since rates are expected to go up, we expect the USD to remain strong against all currencies. The Brexit result will have a major impact on currencies.

Watch Out

Confidence has indeed turned. Liquid stocks and bonds are always first and then come property trouble. Companies that have over geared may be in trouble. I would be cautious about new property deals, so watch those leverage ratios. As for existing deals we need to be in touch with the managers and make sure they are doing a good job protecting cash flow. Moving forward I suspect it is becoming a buyer's market in property. 

As for your portfolio, you have a few choices: take more risk, take less risk or do nothing. This is serious discussion with your financial planner, however our default advice is to do nothing and ride it out.

Israel at a glance

Index

YTD

 Total Return

TA 35

3.04%-

TA 90

3.02%-

TA 125

2.29%-

SME 60

22.96%-

TA Real Estate

10.94%-

The Israeli market was not spared the December panic and had some of the worst weeks in history. Even thought the last few days of the year showed a minor recovery, December would be the major talking point for a long while. Whilst December affected all investors, Pioneer avoided the exposure to the “American Bonds”. These were American property companies that came to Israel to issue cheap debt with sometimes higher risk than the rates they were paying warranted. In October through to December, following some defaults, this entire sector of the market suffered significant losses as attitudes changes completely.

Another notable part of 2018 was the weakening of the shekel from around 3.4 to now close to 3.8:$1. It seems to us that after many years of being strong, the shekel cannot keep up with the rate differential to the USA. As rates increase in Shekels we may see a return of a strong shekel but only after a period of adjustment. In 2019 we expect the bank of Israel to increase rates at least once, possibly twice, each for 0.25%, following the USA model. Even though rates are going up, we see good opportunity in the local bond market following the December sell off. In April 2019 Israel will hold elections, however we expect to see a very similar government to what we had previously so we do not expect a major market impact.


* All the data in the tables is updated according to 31.12.18

The aforementioned information is not a substitute for personal Investment marketing, which takes into account the particular circumstances and special needs of each person. The views expressed in this Review should be considered as market comment for the short term for information purposes only. As such the views herein may be subject to frequent change, are indicative only and no reliance should be placed thereon. This Review does not constitute legal, tax or accounting advice, or any investment recommendation, or any offer to buy or sell financial instruments of any kind, and does not take into account the investment objectives or needs of specific investors. Although this Review has been produced with all reasonable care, based on sources believed to be reliable, reflecting opinions at the time of its writing and subject to change at any time without prior notice, neither Pioneer Wealth Management nor any other entity or segment within the Pioneer International Group makes any representations or warranties as to the accuracy or completeness hereof and accepts no liability for any loss or damage which may arise from its use. The writer and the company are unaware of any conflict of interest at the time of publishing the above commentary.

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About the Author

Mike Ellis

Mike Ellis

Director and Chief Investment Officer

Mike Ellis, originally from South Africa, joined Pioneer in March 2000 after working in the Private Banking & Trust industry in the UK. At Pioneer he was the group CFO for the better part of the last decade. Today Mike serves as a director and is the CIO.

Mike is a Chartered Accountant, a CFA charter holder and received his MBA from Tel Aviv University & Kellogg Business School. Mike is also an Oxford University Alumni having participated in the Said Business School's Global Investment Risk Management Program. In addition, Mike is a licensed Portfolio manager by the Israel Securities Authority.

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