Many of the consensus calls have been wrong in the first half of 2018
Thursday 17 May 2018 Author: Russ Mould

The accompanying table suggests that 2018 is proving anything but straightforward, with many popular asset classes failing to deliver and some unloved ones doing relatively well.

But investors can perhaps draw four lessons from the market action in 2018 so far, as they seek to protect and growth their wealth.

Most investors are, in all likelihood, unlikely to be deflected from their strategic allocations by short-term whirls and eddies in the markets and that is a good thing. It keeps down the risk of being sucked into trying to time the markets and helps to limit unnecessary trading expenses and commissions for good measure.

But for those investors who do have a percentage of their assets set aside for tactical allocations, 2018 has so far offered four trends which should perhaps be borne in mind as portfolios are readied for the summer and then the second half of 2018 and beyond.

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1. Markets are still adapting to QT

While it is interest rates that attract the most attention when it comes to central bank policy, the Federal Reserve’s switch from quantitative easing (QE) to quantitative tightening (QT) is being overlooked.

In addition, the Bank of England has stopped adding to its £445bn programme and the European Central Bank is slowly reducing its monthly stimulus. That leaves only the Bank of Japan going all in on QE, as it continues to run its ¥80trn a year scheme.

The BoJ’s stimulus equates to about $730bn a year – but the Fed will be withdrawing QE at an annual run rate of $600bn a year from October onwards.

That is a substantial decrease in global liquidity after a long span when cheap central bank cash drove bond yields down and equity valuations up.

US investors now need to fund a huge near-$1trn budget deficit by buying this amount of US Treasuries and do so as liquidity is drained away, perhaps putting upward pressure on yields for US Government debt.

If QE really did help stocks, as seems possible, the effects of QT may already be filtering through. After all, the US stock market seem to be providing everything the bulls expected after the Trump tax cuts – rising profits, rising dividends, bumper share buybacks – except positive returns.

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2. Embrace political uncertainty

Most investors will run a mile when confronted by political uncertainty. Yet the UK, dogged by a tangled Brexit debate which seems to be satisfying neither Remainers nor Leavers, is performing relatively well. Brazil is doing better still, even though it is mired in an epic corruption scandal and moving toward a general election.

By contrast, nations where politics are seen as stable and helpful for markets, from India to China and Japan, are doing little to provide positive returns in 2018 – and that’s before we get to the disaster that is Argentina.

Political doubts can drive a currency down, to either provide an economic lift, via exports, or make assets look cheap to overseas buyers (as the wave of mergers and acquisitions in the UK suggests).

Emerging markets may therefore be interesting here, after Malaysia’s shock poll result and ahead of the ballots due in Mexico and Brazil, while this column knows of some intrepid fund managers who are dipping their toes back into Russia (compliance departments permitting) following the imposition of further economic sanctions by the US.

3. Valuation never matters – until it does

The battle lines remain drawn between ‘value’ and ‘growth’ investors.

The loss of absolute momentum in technology stocks (even if they are still doing relatively well) and negative returns from US, Indian and Chinese equities, coupled with the relatively solid returns from UK stocks, would suggest that ‘value’ may be asserting itself.

Professor Robert Shiller’s cyclically adjusted price to earnings (CAPE) ratio as a benchmark would suggest that US stocks may struggle to provide positive returns on a 10-year view, should history deign to repeat itself.

This chart shows the next 10 years’ compound annual returns from the S&P 500, according to the CAPE multiple paid to buy US stocks at the time – and the last three times valuations were this high since 1963 all presaged poor future returns.

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4. Beware the consensus

So far in 2018, a lot of the consensus calls have failed to comprehensively deliver or at least offer investors positive returns (US stocks, tech stocks, India, China) while unloved assets (UK stocks, oil, UK property) have done relatively well.

Perhaps the message is to be prepared for anything and maintain an accordingly balanced portfolio that is as capable of protecting wealth as it is of growing it.

After all, the American writer and humourist Mark Twain once wrote: ‘It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.’

By Russ Mould, investment director, AJ Bell


WHY IS THIS COLUMN CALLED AEQUITAS?

It is the Latin word for equity and the origin of the modern word in both senses – fairness and the value of a company’s shares.

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