2018 turned out to be a rollercoaster year for financial markets. Following a positive start, global equities first sold off in February, although an optimistic sentiment reasserted itself quickly. From a low point in March, markets rallied over 15%, surpassing previous peaks and further stretching some valuations. However, the final quarter of the year was marked with a sharp selloff in October, which evolved into a bear market continuing into the New Year. As a result, a global equity investor would have lost money in 2018 as a whole. For Sterling investors, this is the first time since 2011.
Consequently, the market begins 2019 in a much different state than in January 2018. Investor sentiment is firmly negative, with most focussing on a weakening outlook for global economic growth and tightening monetary policy, as well as a myriad of geopolitical risks. Nevertheless, the selloff has made equity valuations sharply more attractive, with most markets now trading at or below their historical average valuations (on a P/E basis). This should provide some comfort for long-term investors and may soon offer support for markets.
In the UK, the year is likely to be once again dominated by Brexit. The run-up to the March 29th Brexit deadline will undoubtedly lead to volatility as the political brinkmanship intensifies and the possibility of a “hard exit” increases. However, the impact of this is likely to be limited to fluctuations in the Pound and domestically focused UK stocks. Furthermore, it is highly anticipated that in a no deal scenario that the Bank of England would lower interest rates and expand its quantitative easing programme, pushing down yields on gilts and increasing their value. However, given that UK assets are already trading at hefty discounts relative to their global peers, a more favourable outcome may lead to a sharp rally as investors rush to rebuild their positions and international companies looking to buy up UK businesses on low multiples.
Globally, investors will be waiting to see if the predicted economic slowdown in the US develops into a recession, as this will be the primary driver of company earnings and expectations in the shorter term. In 2018, the US economy benefitted from a fiscal stimulus pushed through by President Trump; however, the impact of this has already begun to diminish. Furthermore, it is unlikely that, following the mid-term elections and already high deficit level, any additional stimulus will be available. It is therefore likely that economic growth should, at the least, return to the longer-term equilibrium level of around 2%.
The booming US economy has also led to the Federal Reserve progressing on its programme of interest rate rises and unwinding of their historical quantitative easing. The tighter monetary policy led by the US has been followed by many major central banks globally. However, the resulting inversion of the US yield curve has also spooked investors concerned that the medium-term prospect for the US economy is weaker. The level of interest rates and bond yields will continue to be a primary focus for investors through the course of the year.
The fall in the oil price in the final quarter of 2018 will begin to have more of an impact in 2019. The immediate pass-through of oil prices into fuel has started; however, the full deflationary impact of such a sharp fall will take several quarters to take effect. Inflation expectations globally have therefore been moved sharply lower, with many anticipating that major economies will see headline levels of inflation falling below the 2% targeted level. This will prove to be positive for consumers, who will see an acceleration in their real earnings growth, potentially driving higher consumption. However, producer countries who have only just recovered from the last oil price crash will also begin to suffer, and investment into oil exploration and production will also fall, negatively contributing to economic growth. However, given the speed of change in the oil market and the unpredictable politics of OPEC (Organisation of Petroleum Exporting Countries), the current equilibrium level of oil prices may not stay for long.