2019: Will it be More of the Same? - By Colin Vella

December 2018, apart from marking the end of significantly volatile year, has also resulted in the worst annual decline in a decade, in the United States, for the Standard & Poor’s 500 (S&P 500) Index, which was down by 6.2%, followed by a 5.6% loss in the Dow Jones Industrial Average Index, and a 3.9% fall in the Tech-based index, NASDAQ. Moreover, December 2018 also proved to be the worst December since 1931 for the S&P 500 Index, and in bear market territory (20%+ declines) when calculating the fall since the highs reached during the summer months.

In Europe the same can be said, with the broader Euro Stoxx 600 Index registering the worst decline since the 2008 global financial crisis, with a yearly decline of 13.2%, surpassing the 11.3% fall registered during the European crisis back in 2011.

In essence, with the exception of a very few asset classes and indices – the MSE Equity Total Return Index was up by 3.81% - almost every major asset class registered solid single to double-digit decline in value. By far, the worst performing asset class/market was that within the cryptocurrency sphere, with Bitcoin down by over 70% since the beginning of the year, which still does not make it the worst performing cryptocurrency for the year. It has also been a tough one for crude oil, which registered its biggest collapse since the 2014 crash – down by 25% since October on fears of surging supply and shrinking global demand.

Nevertheless, going back to the traditional major stock market indices and asset classes, the worst performing amongst all was that of China, with the CSI 300 Index shedding over 25% of its market value, equivalent to some $2.3 trillion. Albeit, much of the decline reflects a year of intensifying trade disputes between both China’s Xi Jinping and America’s Donald Trump, it is also believed that substantial influence was observed, following a government campaign against leverage in the financial system – leading to slowing market demand, which according to the financial times, has also forced some funds into liquidation.

What lies ahead?

Further interest rate hikes by the US Federal Reserve, uncertainty surrounding the US-China trade relations, overall global growth prospects, Brexit, as well as the end of Europe’s Quantitative Easing Programme will definitely continue to play a major role throughout 2019, with volatility not expected to die out anytime soon.

Starting off with the US Treasury yield trajectory over the past year and what this might imply to the broader market, the significant investors’ sensitivity to any movements along the curve was observed. Arguably, it is indeed the most watched and influential interest rate globally. It has also resulted into a difficult year for the broader market - having experienced a market environment where high-quality bond prices ended up strengthening throughout the fourth quarter at the same time as further rate hikes took place, and on the back of an unexpected hawkish tone by the US Fed late in December. In a normal market environment, bond prices are inversely related to the direction of interest rates. However, bond prices rallying in lieu with further interest rate hike expectations, only shows that the US Fed tightening will negatively impact the already gloomy US and global growth outlook expectations.

Nevertheless, despite the 10-year US treasury yield reaching a low of 2.72%, most analysts are still, on average, of the opinion that the yield by the end of 2019 reaches the 3.44% level – as per survey conducted by Bloomberg. This would potentially further strengthen the US dollar, as more funds continue chasing higher returns on US assets, but which would negatively impact emerging market bonds in particular, and equities to a certain extent – unless substantiated by improved growth prospects.

Fed policymakers’ meeting late in the month should be duly observed for key indications as to what is on the plate for 2019. Analysts at Credit Suisse have highlighted that an inverted yield curve in 2019 should not materialise, on the basis that the Fed itself will likely regard an already flat yield curve as a warning sign.

Shifting more onto Europe, what will the end of Quantitative Easing mean to the broader market, and how will we cope with it?

The US Treasury market will still have some form of influence over the direction of other sovereign bonds, including Europe. However, the absence of a multi-trillion bond-buying programme that was initiated back in 2015 which buoyed bond prices higher as yields depressed sharply since then, will naturally exacerbate some upward pressure in yields. However, it may be the case that the reversal across yields and bond prices may not be that substantial for a number of factors. The ECB still intends to keep reinvesting the proceeds of maturing bonds already on the bank’s balance sheet, hovering at around the €2.6 trillion level. Moreover, with a number of core Eurozone countries having a balanced fiscal position, Germany in particular, means that limited new supply of debt available to investors will materialise. This will indeed act as a counterforce to the ECB’s absence from the demand side, as supply of new debt will potentially remain scarce for the foreseeable future.

In terms of performance, with respect to both the fixed-income side and the equity side, much also depends on the outcome of the Eurozone economy which has disappointed throughout 2018 after a surprisingly buoyant 2017. In the event of a no-deal Brexit in March, further global trade tensions and deteriorating relations between Italy’s populist government and Brussels will further work as a resistance to any potential move higher across German yields.

European Parliament elections due in May will also play a role as to how any outcome may be challenging to bond investors, on the back of voters’ support behind parties in favour of expansionary fiscal policies – meaning a higher supply of sovereign bonds would be deemed to materialise in such a scenario.

In conclusion, as an investor, I would remain wary of the ongoing uncertainty revolving financial markets, while opportunistically take advantage to tap into high-quality companies which have been depressed indiscriminately as a result of the broad sell-off. As Warren Buffet simply portrays it: “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

This article was prepared by Colin Vella, CFA, anInvestment Advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on Tel: 2122 4410, or email colin.vella@jesmondmizzi.com; http://www.jesmondmizzi.com

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