The investment landscape is offering both opportunities and challenges. The second quarter of 2018 was testament to this, with an undercurrent of risk-off sentiment yet broad market resilience.
A key focal point has been the trade-war rhetoric, with emerging markets being put under significant pressure as capital outflows persisted. This is true both at an asset level and at a currency level, although the fundamental thesis and economic progress is largely unchanged. Related to this development, a meaningful move was a stronger US dollar – especially relative to the euro and sterling – helping bolster returns for non-US investors.
For some time now, investors have had to grapple with the implications of increasing borrowing rates. This theme continued through the second quarter, as most central banks have made it clear that they are either unwinding, or planning to unwind, the monetary stimulus that has persisted for the best part of a decade. This has muted returns from bond markets, especially government bonds with longer duration, whilst inflation-protected bonds continue to be shaped by a rollercoaster of changing inflation expectations. Corporate bonds have also had to deal with a modest rise in bond yields, albeit from a low base, which has hampered performance.
European Markets Robust
Meanwhile, European investors have also had to come to terms with Italy’s precarious political situation and a closing deadline on Brexit. This has dampened risk appetite in the region as investors contemplate the possible repercussions on the European banking system and any contagion risk associated. Tensions related to Brexit have heightened once again, although UK multinationals have generated stronger investor interest, especially as sterling fell over the quarter.
Despite the dual headwinds of European political vulnerabilities and escalating trade-war fears, broad equity markets have managed to deliver reasonably robust outcomes. Strong earnings growth has certainly helped, with US companies in particular continuing to post stellar profit results. Within this, investors have seemingly sought solace in higher-quality investments, sometimes carrying little regard for the price they must pay.
Country and sector dispersion is also alive and well, with an example being the 20% performance differential between US technology and emerging market financials over the past quarter alone, in local currency terms.
More broadly, strength in technology, healthcare and consumer staples was offset by weakness in telecoms and financials. Similarly, at a country level, resilience among companies in the US, Japan and Russia was offset by significant price falls in Brazil, China and Turkey.
The clouded and changing sentiment therefore requires careful judgement. Behavioural changes are afoot: although investor complacency still appears to be widespread, global confidence surveys have generally moved from strong optimism to moderate optimism. Perversely, any continuation of this move could see fear-driven price action and this would be the springboard for great long-term opportunities to develop.
