Annual Review 2018 – Outlook for 2019

In 2018, market sectors experienced contrasting dynamics driven by heightened volatility, global trade tensions, and fluctuating economic indicators, all of which influenced the performance of asset classes and informed positioning for 2019. Here’s a sector-specific analysis of 2018, followed by a strategic outlook for optimal asset allocation in 2019.

2018 Sector Analysis and Performance

  1. Equities:

    • U.S. Equities: The U.S. equity market, particularly large-cap stocks, started the year with solid gains supported by corporate tax cuts, deregulation, and a strong labor market. However, volatility surged by October due to fears of overvaluation, the Federal Reserve’s rate hike trajectory, and escalating trade tensions with China. The S&P 500’s initial strength faded in the last quarter, finishing down 6.2% for the year, marking its worst annual performance since the financial crisis. Notably, sectors like technology and consumer discretionary were among the hardest hit, while defensive sectors such as utilities and healthcare provided relative stability amid the downturn.

    • European Equities: In Europe, markets struggled throughout the year under the weight of slower economic growth, political uncertainties (notably Brexit and Italy’s budget issues), and the European Central Bank’s (ECB) gradual shift towards ending quantitative easing. The Euro Stoxx 50 index, a benchmark for European equities, underperformed its global peers, reflecting tepid growth and low business confidence across the region. German export-driven sectors, particularly automakers, were negatively impacted by trade disputes and reduced demand from China, further weighing on market sentiment.

    • Asian Equities: Asia was a focal point of volatility, with China’s CSI 300 index declining almost 27%, driven by domestic economic deceleration, regulatory tightening, and the intensifying trade war with the United States. The economic impacts were particularly stark in export-driven economies like Japan and South Korea, where industrial and manufacturing sectors suffered under diminished trade volumes. Meanwhile, Hong Kong’s Hang Seng index saw its worst annual performance since 2011, underscoring the broader region’s vulnerability to both external trade pressures and a cooling domestic economy.

  2. Fixed Income:

    • U.S. Treasuries: U.S. Treasury yields climbed in the first half of 2018 as the Federal Reserve implemented a series of interest rate hikes, pushing the 10-year yield over 3% by Q4. This surge reflected both economic strength and inflationary concerns, though heightened market volatility in Q4 brought a return to Treasuries as investors sought safe-haven assets. The inversion in parts of the yield curve towards the year-end hinted at potential economic slowdown, making longer-duration Treasuries attractive as a hedge against future rate cuts.

    • European Bonds: European fixed income markets remained relatively stable, with low yields persisting due to the ECB’s ongoing accommodative policy stance throughout most of the year. By year-end, however, the conclusion of the ECB’s quantitative easing program created a shift in outlook for 2019, with expectations of gradual rate hikes. Peripheral bonds, particularly Italian debt, were volatile due to political friction, whereas German bunds remained a cornerstone for investors seeking security amid Brexit and broader EU uncertainties.

    • Corporate Bonds and High Yield: The corporate bond market faced increased risk aversion as credit spreads widened, particularly in the high-yield segment, where concerns about economic deceleration led to significant sell-offs. High-quality investment-grade bonds in the U.S. held up better, benefiting from flight-to-quality flows, though the entire corporate bond space reflected increased caution towards rising leverage levels and refinancing risks in a potentially higher interest rate environment.

  3. Commodities:

    • Energy: Oil saw a rollercoaster year, starting with gains driven by supply constraints and robust demand, only to plunge in the latter months due to fears of oversupply and slowing global demand. WTI crude peaked above $70 in mid-2018 but fell to around $45 by December, reflecting the broader shift in economic expectations.

    • Precious Metals: Gold and other precious metals performed relatively well, especially in Q4, as equity market volatility and a more cautious Federal Reserve bolstered their appeal as safe-haven assets. Gold prices benefitted from demand related to currency hedging, with central banks also increasing their gold reserves as a counterbalance to potential U.S. dollar weakness.

  4. Real Estate:

    • Real estate investment trusts (REITs) and real estate sectors, particularly in the U.S., showed mixed results. Rising interest rates presented challenges, increasing the cost of capital for many REITs. However, sectors focused on logistics and industrial properties saw stable demand growth, supported by e-commerce trends and supply chain investments. European real estate markets were more vulnerable, with political uncertainties dampening commercial property investments, particularly in the U.K. where Brexit’s long-term impact on property values remains unclear.

2019 Asset Allocation Prospects and Strategic Rationale

  1. Equities Allocation:

    • U.S. Large-Cap Defensive and Growth Sectors: Given the cautious outlook on economic growth and potential Fed easing, a strategic allocation to U.S. large-cap equities in defensive sectors like healthcare and consumer staples could offer stability and capital preservation. Growth sectors like technology, though volatile, could present selective opportunities, especially in cloud computing and cybersecurity, where demand remains robust even amid cyclical concerns.

    • Emerging Markets with Caution on China: While emerging markets (EM) faced headwinds in 2018, valuation discounts and potential policy shifts suggest selective opportunities, especially in Asia outside China. However, caution is warranted in China due to persistent economic and regulatory risks. Countries with favorable demographics, like India and Vietnam, could offer growth avenues less impacted by trade wars and more supported by domestic demand.

  2. Fixed Income Allocation:

    • U.S. Treasuries and High-Quality Bonds: Given the yield curve inversion seen in late 2018, long-duration U.S. Treasuries offer defensive positioning, potentially benefiting from future Fed rate cuts if economic conditions soften. High-quality investment-grade corporate bonds, particularly in defensive sectors, can provide additional income stability and mitigate credit risk. Short-duration Treasuries are also attractive to hedge against potential short-term interest rate increases.

    • European Bonds, Primarily German Bunds and Select Corporates: In Europe, bunds remain the safest fixed-income asset amid political uncertainties. For higher yields, select investment-grade corporates in Northern Europe could add income potential without excessive credit exposure. While high-yield and peripheral bonds present some return potential, they carry elevated risks and may be better suited for tactical positions than long-term holdings.

  3. Commodities and Alternative Investments:

    • Gold and Precious Metals: Gold remains a key asset in a balanced portfolio, offering a hedge against equity volatility and potential U.S. dollar weakness. With central banks ramping up gold purchases, precious metals continue to be a strategic allocation to counterbalance equity market risks and inflationary concerns.

    • Energy and Select Commodities: While crude oil faces demand risks tied to global economic health, supply constraints and OPEC policy adjustments could provide support. An allocation to energy commodities can also serve as a natural inflation hedge, though with cautious sizing given the sector’s inherent volatility.

  4. Real Estate Investment:

    • Industrial and Logistics REITs in the U.S.: Sectors driven by long-term growth trends, like logistics real estate, are well-positioned as e-commerce demand rises, supporting industrial property values. However, traditional retail and office REITs face more pressure from interest rates and economic deceleration, so these should be approached conservatively.

    • European Real Estate with Caution on U.K.: European real estate offers select opportunities, especially in Germany and Scandinavia, where economic fundamentals remain relatively stable. In contrast, U.K. real estate may continue to face challenges due to Brexit-related uncertainty, making it a cautious play until more clarity emerges.

Strategic Outlook for Winning Returns in 2019

For 2019, a balanced and diversified approach is paramount, with defensive equities, high-quality bonds, and alternative assets playing central roles in a conservative allocation. In equities, the strategy should favor U.S. large caps with a bias towards defensive sectors and selective EM exposure, focusing on regions with less direct exposure to trade disputes. In fixed income, U.S. Treasuries provide both safety and potential appreciation, while select corporates can add income. Alternatives, particularly gold, act as a valuable diversification tool against market swings and potential currency fluctuations. This strategy offers resilience against volatility while maintaining growth potential in sectors poised to benefit from macroeconomic and demographic trends.

Source: Bloomberg

Source: Bloomberg