In the coming year, tightening labor markets, rising wages and reasonably strong economic activity in the US will continue to lead the Federal Reserve (Fed) to increase rates. There is, of course, a risk that the Fed will tighten too quickly, and that the combined effects of balance-sheet reduction and conventional rate hikes may contract economic growth much earlier than expected in 2019; while this is not our central forecast, it is a risk we remain acutely aware of.
Higher rates are not going to be good news for some expensive equities out there (especially for the stocks of companies which have gorged on cheap liquidity for the last decade), as among other things they mean higher borrowing costs. As such, we expect to see volatility persisting in equity markets for some time to come.
Clearly, there is a risk that the global trade war that came to the fore in 2018 will worsen in 2019, bringing with it the wrong type of inflationary pressure – that is, the regulatory-driven kind. This has the risk of ushering in a sharp slowdown to global activity, while pushing central banks towards more tightening measures – an unpleasant combination for equity markets.
Looking at Europe, uncertainty around Brexit – specifically the shape of the final ‘divorce’ deal – and Italian sovereign risk will both be a preoccupation for markets. Central bank policies will also remain an important focus, in the context of economic momentum which could be weakening across the European Union, China and the US.
Opportunities for Long-term Investors in 2019
The market is also becoming increasingly anxious about risks of a recession, which is likely to add further volatility in 2019. There is certainly the potential here for investors with a shorter time horizon to be spooked. However, we believe these risks create opportunities for long-term investors such as ourselves. Specifically, to initiate holdings in companies that we see as being exposed to long-term secular growth drivers at attractive valuations.
From our standpoint as international equity specialists, we continue to see a huge amount of opportunity for investors looking beyond their domestic markets. For instance, optically, emerging market equities are around their long-term price-to-earnings average. However, we believe the asset class still represents good value in terms of an international equity allocation. Return on equity is fairly synchronised with developed markets, as represented by the MSCI World index. Importantly though, price-to-book and price-to-equity values remain low relative to history and developed markets.
Attractive Emerging Market Valuation
Source: Bloomberg, as of 10/31/18. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Meanwhile, despite M&A activity in 2018 reaching record levels (both in the number of deals and the size of those transactions), we believe the market might be underestimating the possibility for this activity to accelerate even further in 2019. This will have the potential to bring periods of euphoria to the market as we have seen in the past at this late stage in the cycle.
The ESG Perspective in the Coming Year
Elsewhere, from an Environmental, Social and Governance (ESG) perspective, we are going to see an enhanced level of focus on climate-change reporting in 2019 and beyond. Both investors and companies will need to think more about how they manage and report on systemic issues such as the recommendations from the Task Force on Climate-related Financial Disclosures (TFCD) and the UN Sustainable Development Goals (SDGs), specifically goal number 13 – Climate Action. For companies, this is a matter of strategy and sustainable value creation. For investors, particularly like ourselves with longer-term time horizons, these (climate-related) systemic risks will be increasingly reflected in valuation models and incorporated into engagement with company executives and board members.
For some companies, increasing focus from investors on transparency also poses a risk. As we move into 2019, the World Benchmarking Alliance, a body set up with the aim to fill the accountability gap in measuring corporate performance in relation to the SDGs, will start to publish publicly available benchmarks. These will rank companies on their performance and incentivise business action towards achieving the SDGs.
Finally, the issue of plastic waste has generated significant attention in the past year and is therefore likely to feature even more prominently in our thinking in 2019. As global awareness of this problem rapidly increases, the phasing out of single-use plastic will move higher up the agenda for both consumers and investors alike. This is already having significant implications for some consumer goods companies, as well as those within the plastics value chain, so we will be spending considerable time understanding how business models (and ultimately long-term margins) will be changed by a drastic reduction in plastics use.
2019 Investment Outlooks
The Limits of U.S. Growth
An Extended Business Cycle
Liquidity is the Question
A Plethora of Risks
Current Volatility, Long-Term Opportunity
Choppy Markets Ahead
Time to Get Defensive?
Royce & Associates
A Shift Toward Cyclicals
Focus on Growth
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"Brexit" is a shorthand term referring to the UK vote to exit the European Union.
The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.
Mergers and acquisitions (M&A) is a general term used to refer to the consolidation of companies. A merger is a combination of two companies to form a new company, while an acquisition is the purchase of one company by another in which no new company is formed.
The MSCI Emerging Markets (EM) Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The MSCI World Index is an unmanaged index of common stocks of companies representative of the market structure of 22 developed market countries in North America, Europe, and the Asia/Pacific Region. The index is calculated without dividends, with net or with gross dividends reinvested, in both U.S. dollars and local currencies. Please note an investor cannot invest directly in an index.
The price-to-book (P/B) ratio is a stock's price divided by the stock’s per share book value.
The price-to-earnings (P/E) ratio is a stock's price divided by its earnings per share.
Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/Shareholder's Equity.
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