Investors have enjoyed superb returns on their portfolios in 2019. Markets have extended their rally this year with major equity indices returning more than 20 per cent since the start of the year. Typical risk-mitigating assets, such as government bonds, have also performed positively.
Volatility was very low with hardly any episodes of disruptive shocks throughout the year. Multi-asset strategies also benefited investors in an environment where traditionally low-correlated asset classes experienced relatively high correlation in a booming market.
The first quarter was mainly driven by the recovery of the market drawdown seen in the last quarter of 2018, which was triggered mainly by the Fed’s U-turn. Then, market participants sequentially shifted focus from one issue to the next. Overall, one can say that everything has gone well this year.
Practically all central banks in developed economies have reasserted their dovish stance.
The Fed, in particular, is actually doing more than was originally anticipated. The recent injection of liquidity through open market purchases of US Treasury-bills is seeing the size of its balance sheet reversing course and expanding once again.
The reins of the ECB have been officially handed over to Christine Lagarde who reiterated Mario Draghi’s stance to support easy monetary conditions and is seen to put more pressure on policy makers to do more on the fiscal side.
The Bank of England has shifted from a relatively hawkish, or mixed, stance to a ‘wait-and-see’ approach given developments on Brexit and UK politics.
On that note, geopolitical uncertainties have ameliorated to an extent with Brexit entering the next phase following the decisive outcome of the very recent UK election. Moreover, trade tensions have also eased for the time being with US and China agreeing on a ‘phase one’ truce.
So all in all it has been a very good year for financial markets, both for absolute returns and for risk-adjusted performance measures. In fact, the bar is set quite high up for a repeat of such a performance in 2020.
With so much good news already reflected in asset valuations, a similarly strong market performance is difficult to materialise next year
With so much good news already reflected in asset valuations, a similarly strong market performance is difficult to materialise next year. We have seen some very important short-term wins on the main issues which drove market sentiment in 2019, but the reality is that deeper and longer-term challenges still remain. This is particularly relevant in the current transitory period of policy handover where central banks seem to have run their course and the baton is being passed on to the governments to shore up business and economic activity through fiscal measures.
First and foremost, the trade situation and the resulting tensions and uncertainties are here to stay. This is because of the fact that there are longstanding fundamental disagreements between US and China. These primarily relate to the lack of protection of intellectual property, forced technology transfers, the controversial subsidies to statal enterprises and businesses and, now, the possibility of national security issues.
On all of these fronts, the US, and possibly even other trading counterparties including European countries, at some point will require clearer reassurances from China on fairer trade practices.
The phase one deal has provided some relief in trade tensions and removed the risk of re-escalation in the short term. Moreover, it is also allowing the trading parties to better define their objectives giving hope for a more comprehensive solution. Having said that, with China being poised to become the world’s largest economy, the appetite to compromise seems low – even though this would bring short-term political benefits for both parties.
So as we enjoy this period of truce, the fact is that the trade issues are too complex, and subsequent episodes of heightened trade tensions are bound to happen again in the foreseeable future.
Another important factor of uncertainty is the economic challenges in Europe including the uncertainty surrounding the post-Brexit relationship between the UK and EU. Boris Johnson is already seeking to hard-code an exceptionally tight deadline to finalise a trade agreement which some are viewing as posing a greater risk of a cliff-edge fall-out in a post-Brexit world.
These longer-term uncertainties will remain the main headwinds for business investment especially in trade-oriented sectors which is the main driver of growth in export-oriented economies. Therefore, in the absence of more concrete steps by policymakers to reduce political uncertainty, the lack of traction in business investment will remain the main drag on global economic growth in the medium term.
While we cannot lose sight of the core of these issues, one must acknowledge that the short-term developments are hinting towards a pick-up in economic activity.
This is the right opportunity for policymakers to work decisively towards creating a pro-growth environment and empowering domestic expansion in order to lift productivity and boost growth potential with the aim of increasing resilience and growth sustainability.
In this period of policy handover, improved economic fundamentals can better validate the elevated asset valuations and provide support for continued expansion.
The expectations of a reaccelerating economic growth outlook combined with the receding trade tensions, overlaid on a pronounced bias by central banks to maintain a dovish tilt for longer, are shaping market projections for a modest financial market performance in 2020. Markets are eyeing a large probability of relatively lower, single-digit returns, and a small probability of larger negative returns.
Matthias Busuttil is a senior portfolio and investment manager at Curmi and Partners Ltd.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.