2018 ended with an awful quarter for global markets, capping off the worst year for world markets since 2008. After the falls of October and December, global equities (MSCI All Country World Index including dividends) were down 3.8% for the year whilst UK equities (FTSE All Share including dividends) fell 9.5% over 2018.
Bonds performed much better than equities, but even positive returns for developed market government bonds were miserly, whilst riskier bonds also fell over the year. Oil, after having risen for the first three quarters of the year, fell precipitously over the fourth quarter to end the year almost 20% lower than where it started, with most other industrial commodities also showing steep losses.
Brexit isn’t a systemic risk to portfolios
The reasons for the global sell-off were numerous, complex and interconnected, but centred on worries that an ageing global economic expansion was going to be brought down by one of or a combination of the following: overly aggressive US central bank tightening, a collapse of global trade caused by the US/China trade dispute and/or China’s debt build-up.
There were certainly more localised worries too, such as Brexit. But Brexit, whilst important to UK citizens and relevant to UK assets, isn’t a systemic risk to a properly diversified global portfolio because a bad Brexit is unlikely to derail the world economy. A US or Chinese recession, on the other hand, almost certainly would.
Downsides…and upsides
Looking forward, the downside risks (both global and local) are very apparent: currently softening global and US growth, trade tensions, a hard Brexit, high leverage in credit markets and high debt levels in China and tricky eurozone politics. But there are possible risks to the upside too, in the form of a trade deal between the US and China, avoidance of a no-deal Brexit and further Chinese stimulus.
In addition, a lower oil price has the potential to boost global growth (particularly in oil importing Europe, Japan and China) whilst lowering the need for further US interest rate rises, something which could be very positive for emerging markets as a whole, despite causing issues for particular oil exporters like Russia and Saudi Arabia.
Diversification is king
In the face of all this uncertainty our portfolios remain well diversified, with positions like government bonds and cash present in case the worst happens and we get a global recession, although we think this is unlikely. Likewise, in the case of a no-deal Brexit, portfolios contain decent allocations to offshore assets and foreign currencies that should provide some protection in the case of sterling devaluation and a fall in UK equity prices. But whilst remaining diversified, portfolios do have definite tilts to areas where we see a lot of value, such as UK domestic equities, Japanese equities, small caps and even emerging market equities, all assets that should do very well if our central cases of no bad Brexit and no global recession in 2019 play out.
As we have done since we started PortfolioMetrix, we’re constantly monitoring portfolios and we won’t hesitate to make changes where we think they’ll increase risk-adjusted returns.
