Welcome to Psigma’s latest Quarterly Market Review.
In this edition, our CIO Tom Becket will provide an overview of market activity during the third quarter of 2018. He will also explain how we expect the remainder of the year to continue, with particular focus on our client portfolios, our expectations for future returns and the likely path of progression of our investment strategy.
Greetings and welcome to our review of the third quarter of 2018. Now life moves pretty fast as we all know and by the time we shot this video in mid-October a lot had also changed from the effects of the markets we had seen so far this year; so in today’s video I’ll not only review what happened during a topsy-turvy third quarter for markets in the global economy, but also put some flavour behind what’s happened so far in the fourth quarter of 2018 and set out our views for the rest of 2018 and what might happen as we move into a new year.
So equity markets around the world reflected the economic conditions that we were seeing as we progressed through the third quarter, and in fact there was a great divergence both in the terms of the economic growth and performance, and indeed the performance of the various different equity markets around the world. The leader was undoubtedly the US; the US S&P 500 posted a very positive return in the third quarter and that was really a reflection of the fact that US corporate profits were strong, helped by the tax cuts the Trump administration gave US companies at the end of 2017 and also the fact that actually the US economy was also doing really quite well at that juncture. On the flipside we actually saw a less impressive performance from the UK FTSE All Share, which lost a small amount of money in the third quarter and that was a reflection really of the fact that the UK economy remains in a difficult place and people have a great deal of nerves about investing in the UK, due to the ongoing political situation particularly around our exit from the European Union. Other markets like Japan and Europe actually posted small positive returns but nothing really to write home about, and like before what we saw in the UK, actually emerging market investments also came under the cosh once again, particularly on a relative basis, and that was a reflection of the fact that concerns have risen around global trade, and concerns have risen around specific emerging markets. So really we can describe the third quarter as being a period of great divergence from the form of equity markets around the world.
Fixed Interest Markets
So equity markets were quite challenging. To put it into context we saw a return ranging all the way up from about 10% positive return for US equities, all the way down to a negative return for emerging markets. On the flipside in bond markets it was pretty much a case of just most fixed interest investments losing money in the third quarter. And the worst performing investments were actually those considered to be the safest or the highest quality government bonds and very high quality investment grade corporate bonds; and the chief reason was a move higher that we saw in market interest rates driven by interest rate expectations around the world rising, due to the strong performance of the US economy and because of the rising inflationary pressures that we saw across the global economy. This is obviously a big change in what we have seen in most of the last decade, where market interest rates were falling and people were concerned about deflation, and people were worried about growth being too low; so something has changed and we have moved into another dimension when it comes to fixed interest markets over the last few months.
Now one bright spot again in the third quarter was the performance of various different credit instruments around the world. Now we highlighted this in a specific section in the second quarter, but we’ll do so again today because we’ve seen very good performance from credit instruments as people have embraced the hunt for yield trade around the world and tried still to find income in a wold where interest rates might be rising, but it’s still very hard to generate an income and certainly from the perspective of our portfolios our overweight in higher risk credit instruments in the third quarter continued to deliver the goods for our clients’ portfolios and we expect this to continue and it’s a trade we are very much backing with conviction as we head towards 2019.
End of Year Expectations
So as I said earlier on in today’s piece, we’ve so far seen three distinctly different quarters for the global economy and global asset markets so far this year. In the first quarter we saw broadly negative performance from most asset markets around the world. In the second quarter that was reversed and most asset markets around the world posted healthy positive returns, and in the third quarter we saw a great divergence as I referred to earlier between those investments which did well and those investments which lagged behind. Now in the fourth quarter so far we’ve seen a great deal of volatility and we’ve seen a lot of asset markets around the world perform quite poorly. Now we expected that might well be the case and we were certainly positioned for that as we headed into the fourth quarter. But now our view has changed once again. We expect markets to continue to be volatile; to continue the pattern we’ve seen so far this year but at the same time we’re very much of the view that equity markets will recover at some point in the fourth quarter and that there will be a change in leadership between those things which led in the third quarter and those things which have got the most recovery potential as we head towards 2019. Now amongst those contrarian opportunities we would class things like emerging market equities, markets like Japanese equities, perhaps some European equities and we’ve started to make some changes to our strategy as we move through the fourth quarter. The first thing we’ve done is taken off some of the hedges which served us well through the last few weeks in recognition that the hedges actually paid off and actually as we move forward from now they might be a bit less necessary than they certainly have been in the first few weeks of October. And the second thing we’ve done is start to move money back into equity markets. Now obviously it seems like a pretty difficult marketplace out there in this point in time, but some of the best investment decisions are made when markets seem toughest and that’s certainly appropriate at this point in time. Now the decisions were are taking are tactical; we expect 2019 to be a difficult year for asset markets and we’re likely to become more defensively positioned as we head towards next year, but markets have fallen quite a long way; they’re potentially oversold and we expect a recovery as we move towards the end of the year, so increasingly we are starting to position our portfolios in expectation in respect of that particular view.
So in terms of our strategy I have already said that we have started to tactically become a bit more “risk on” with regards to our portfolios. Now I don’t want that view to overwhelm the core views that we currently have behind our positioning which have become more cautious over the last few years; 2016 and 2017 were excellent times to be investors and we’ve already expected 2018 to be a more difficult time to make money on behalf of clients. Our portfolios also remain incredibly diversified; we haven’t necessary just gone for the sake of having lots and lots of investments for that sake of diversification but rather trying to find differing themes and different investments that can help both us maximise the opportunity set and minimise the risks that are out there whilst also trying to hopefully produce a positive return over the next few years. But as I’ve said we very much expect that positive return generation to become much more challenging than it has been for the last few years. So in very simple terms our portfolios are quite cautiously positioned but we are taking a more tactical approach now to increasing risk and we’re also extremely diversified in expectations of the volatility we’ve seen so far in 2018 to be a feature for the remainder of this quarter, and as we move into 2019.
So sadly our prediction from the start of this year that it was going to be difficult to make a positive return has so far come true, certainly in the life of an asset allocator and someone who picks investments has become more challenging from the easy street environment that we saw in 2016 and 2017. Now some good things have happened so far this year; obviously we shouldn’t like the fact that asset markets have fallen, but the reset that we’ve seen have given us the opportunity to once again reload the gun and go for decent contrarian opportunities that we think can bring positive returns in the next few years but really I think our core message for clients and followers of this view is that markets have become more challenging as we move into next year economic risks have risen as will forecasts I will discuss in future video blogs and actually now is a time to be more cautious than you have been for much of the last ten years and trying to make positive returns is likely to carry on being difficult, but we believe very much that we have the strategy and the specific investments to try and make those positive returns and have high confidence that our strategy is a sensible one for the more difficult environment ahead.
So what remains to be said is thank you very much for watching and I hope you have a great end of the year. Thank you.
Chief Investment Officer
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