As we enter the final month of 2018, we have a lot to absorb. Yet, perhaps the core message is that beaten-up assets can do surprisingly well. To set the scene, we have had no shortage of topics on the boiler, including the oft-referenced Brexit, Italian liquidity, trade negotiations, oil-supply decrees, and central bank decisions, to name a few.
Amid the noise, many forget the important role valuations can play, with the decade-long bull run for global equities losing steam and impacting some pockets of the market more than others. In this regard, the market setback of October slid into November, although a late recovery alleviated some of the pain.
This recovery was fragmented, with Asian equities staging an impressive rebound in late November, leaving behind large parts of the Americas and Europe. In fact, November was quite an ugly month for Europe broadly, with 61 of the 88 equity asset classes we monitor in pan-Europe falling. Interestingly, Italy was one of the few to deliver a positive outcome despite the well-publicised risks surrounding banking liquidity.
Also, among the big movers were oil-related assets, but they went the other direction. Following a strong run, oil was particularly hard hit, with crude oil falling by its biggest monthly margin in a decade, down 22% over November alone in U.S. dollar terms.
By extension, the performance of many energy companies were dented, leaving it as the worst-performing sector in November and sending returns into the red over a 12-month period.
November Sees Bounce Back for Asia
It was a month to remember for emerging markets, with sentiment turning around following an extended period of weakness. The rebound included both equities and local-currency debt, with these assets ranking among the strongest-performing assets for the month and pulling back some of the losses incurred year-to-date. China, India, and Indonesia all contributed positively.
UK equities were less spectacular, although contained much of the losses amid the rather extraordinary Brexit negotiations. During the chaotic ramblings, the multinational companies, loosely represented by the FTSE 100 Index, continued to hold up reasonably well against the domestics, better represented in the FTSE 250 Index.
This multinational-domestic story has been positive in a relative sense, despite sentiment remaining poor across the board, highlighting a possible contrarian signal for those with a long-term view.
Elsewhere, fixed-income assets were again quite muted. It was the higher-quality bonds that were the better performers, with corporate bonds failing to add value amid the volatility and widening credit spreads. Of note, the U.S. dollar fell late in November relative to the other major currencies, albeit from a high base. This resulted in a reasonably flat currency outcome for the month, having little impact on returns.
The Bigger Picture
With only a month left in 2018, many will start to reflect on what has been and what we can learn. In truth, a lot has already been said about the drivers of the recent downturn, although we’d warn against placing such emphasis on a particular trigger. The more likely is that it is a multifaceted challenge, with a series of negative surprises now getting baked into prices and the growing uncertainty rattling investor sentiment.
We’ll similarly be reflecting and learning. As we do, a key takeaway for us is that we must not be short-sighted in our search for fundamentally-attractive assets. To bring this to life, we can see that emerging markets have underperformed the U.S. by around 90% over five years and 170% over 10 years.
Europe has similarly underperformed the U.S. by around 90% and 215% over the respective periods. Part of this may be justified by the fundamentals, but if we dare to dig a little deeper, the extremities become apparent.
So, where does that leave us? In the short term, it is anyone’s guess, although we can see some interesting opportunities presenting themselves on a valuation basis. For the most part, these opportunities overwhelmingly exist away from the U.S. market, which has had an extraordinary run with little precedent.
Of course, building portfolios on a valuation-driven basis requires careful navigation too, with risk management and patience likely to play important roles. This stems from asset allocation to investment selection and all the way through to the underlying currency exposure. In this sense, one of the greatest behavioural traits is to acknowledge what we can’t know versus what we do know.
To bring this together, we can appreciate that the current market condition is unsettling for some. It is at these moments we encourage everyone to stop and pause, using evidence and perspective as their guide. That is, our greatest opportunity to add value comes off the back of disorder and extremes, acting rationally when others won’t or can’t.
Compellingly, beaten-up assets – like emerging markets most recently – can do surprisingly well when people least expect it.
