Last year investors experienced volatile markets. Nonetheless, markets started the new year in rally mode within a macro-economic and political context of significant issues such as Brexit and the China-US trade war. Investors are now asking which asset classes will generate positive returns in 2019 and beyond. Two investment managers at Calamatta Cuschieri answer typical questions on the equity and fixed income markets.
Equities
Do you expect 2019 to be a good year for equities?
KC: For 2019, we anticipate weaker but sustained global economic growth, with an increase in corporate profits, which remains a constructive scenario for equities. Accordingly, our return expectations for equities in 2019 are in the mid to higher single-digit percentage range. However, we continue to expect increased volatility.
Where are we regarding valuations?
KC: Company valuations fell considerably in 2018. This corresponds to an unusually large devaluation for times outside of a recession. A sustained positive earnings trend should provide support at these levels. We believe that the pessimism towards European and emerging market equities is overdone.
What are your views on the China-US trade war?
KC: We believe the potential for a compromise is higher given that US companies started to feel the pressure from a slowdown in China.
What are your views on Brexit?
KC: Our base case remains a negotiated exit agreement. Look for companies that will benefit from a stronger currency and an improvement in consumer sentiment. These being retailers (Next), banks (Lloyds) and homebuilders (Taylor Wimpey).
Which sectors do you expect will outperform the market and why?
KC: There are a number of sectors, which we like. These being:
The Basic Resources sector is one which should benefit from any positive agreement between the US and China. We like the iShares stoxx Europe 600 basic resources ETF. The consumer discretionary sector has de-rated dramatically in 2018 as investors went into safe havens. Today, this sector is trading on cheap valuations. Companies like LVMH, Alibaba and Amazon are the ones to watch.
The technology sector has delivered much stronger EPS growth than the broader market in the past few years. We are watching Microsoft and ASML. On the other hand, the pharmaceutical sector is one where we expect to see an improvement in margins as more drugs get approved and demand continues to increase. We look favourably at Sanofi and Astrazeneca.
The insurance sector, with firms like Allianz and Munich Re, are displaying strong balance sheets, the result of a clear focus on improving capital over the last few years.
Fixed income
What is your outlook for the bond market in 2019?
JP: Last year was difficult for bond markets conditioned by tighter monetary policies and geopolitical tensions. For 2019, we see value following the abrupt U-turn by leading central banks, which fear an economic slowdown. We view the easier monetary stance as a catalyst for bonds. However, we are of the view that the magnitude of returns will differ amongst regions.
Are investment grade (IG) bonds attractive following negative returns in 2018?
JP: I think the regional aspect is important, as the potential returns from US IG might be greater than European IG. Giving a very practical example, Apple medium term dollar bonds were very sensitive to the rate hikes in the US. This recent drop in price is offering the opportunity to investors to dip in at attractive levels from a risk-adjusted aspect. I think we are in consensus that the probability of Apple defaulting is close to zero and thus these are the opportunities investors should take when markets move. Therefore, we view US IG as selectively attractive.
In Europe, the situation for IG is slightly different as in Europe we have not experienced a factual rate hike and thus spreads failed to widen to the same magnitude as their US counterparts, despite the European Central Bank’s softer tone. So despite selectively there might be opportunities, I cannot see much upside.
Can investors still generate medium to high single digit returns from the bond market?
JP: Very bluntly, yes. Once again, the regional aspect comes into play. For the first time since 2016, in late December 2018, we’ve viewed European HY tempting following the fall in bond prices. Selectively, European HY still offers value. Yet emerging debt is an attractive region where investors can generate high single digit returns primarily following last year’s sharp declines. A case in point is Indonesia on the back of a severe correction in its local currency, which hit harshly dollar Indonesian bonds. We also like Brazilian bonds, which continued to show an improvement in their financials and the telecommunications sector in other EM regions.
Overall, we view that a prolonged dovish stance and a more positive outcome from the trade-war saga, bond markets in 2019 should perform relatively well with different geographical regions outperforming others.
Kristian Camenzuli and Jordan Portelli are Investment Managers at Calamatta Cuschieri. The information, views and opinions provided in this article are provided solely for educational and informational purposes and should not be construed as investment advice, tax or legal advice. This article was issued by Calamatta Cuschieri Investment Services.