Review of Investment Markets for Q4 2018

General Overview.

Global Equity markets retreated in the fourth quarter of 2018, with October seeing the sharpest one-month decline for global equities since May 2012, despite a rally at the end of that month. Both equity and bond markets grew cautious in the face of a number of factors, including rising US interest rates, signs that trade tensions are fuelling a global economic slowdown, some disappointing earnings data from ‘big tech’ companies and a budget dispute between Italy and the European Union. The price of oil fell almost 9% over the month to US$75, as Saudi Arabia pledged to increase production to cover any shortfall left by Iran.
After October’s sharp falls, global equity markets regained some of their poise. The combination of a less aggressive tone concerning interest rate rises from the US Federal Reserve (Fed) and the easing of trade tensions between the US and China saw global equity markets deliver modest positive returns in November. Government bond yields were broadly lower with US 10-year Treasury yields reaching a seven year high of 3.24% before falling back to 2.99% by the end of November. Brent crude oil continued to fall to US$58 per barrel during November, the lowest value seen in more than a year.
Despite solid economic data, equity markets across the globe underperformed in early December, blighted by issues surrounding international trade, US central bank policy, and ongoing Brexit turbulence. By mid -December, concerns over the outlook for economic growth and the effects of rising interest rates on borrowing costs fuelled steep declines in US equities and global markets. Prime Minister Theresa May endured a rollercoaster time, postponing the parliamentary vote on her Brexit deal, and surviving a ‘no confidence’ vote in her leadership of the Conservative Party. There were signs of some thawing in the diplomatic frost between the US and China, as President Trump’s rhetoric appeared to soften, while China lowered tariffs on US autos and began importing US commodities once more. However, in the run up to Xmas, the US Federal Reserve announced their final interest rate hike for 2018. Traders became concerned that the FED would press ahead with further interest rate hikes next year despite a softer economic backdrop and defying pressure from President Donald Trump to hold rates down. Global Markets did rally though as trading resumed following the Xmas break.
Utilities and health care were the only two sectors in positive territory approaching the end of 2018. They are traditionally referred to as “defensive” sectors because the goods and services they supply should remain in demand even if the economic outlook isn’t great. Among the worst performing sectors are basic resources and materials, which are used in construction, as well as banks and autos. These are traditionally referred to as “cyclical” sectors because demand for the goods and services they supply is typically dependent on the health of the economy: the better the outlook, the better they should perform.

Global Equities

The following chart reflects the performance of the MSCI World index over 2018, falling approximately 12% over the fourth quarter of 2018, in sterling terms, giving back the gains made over the summer.

The MSCI World is a market cap weighted equity market index of over 1600 stocks from companies throughout the world, although excludes companies in emerging and frontier markets. It is a widely used benchmark to assess how equity markets have performed globally.
 

US Equities

The US equity market ended October in negative territory as technology shares fell out of favour and markets grew concerned about US-China trade tensions. It was a volatile month overall for the US equity market, as concerns about the global economy, the trade war with China, the outlook for technology companies and the pace of interest rate rises all weighed on market sentiment and casted doubt over how much longer the long running equity bull market could continue for.
The technology sector was at the centre of weakness during October. Amazon gave a cautious outlook for the Christmas holiday shopping season and Alphabet revealed that its advertising business had slowed by more than expected in the third quarter. The scale of the drop undoubtedly soured sentiment. However, it was Facebook’s earnings topping expectations which helped drive the two-day rally at the end of the month – the biggest two-day surge for the US equity market since February, helping to offset concerns that corporate profitability may have peaked.
Markets were encouraged by US economic growth which expanded at an annual rate of 3.5% in the third quarter. Buoyant consumer spending – which accounts for over two-thirds of the economy – drove US economic growth beyond analyst expectations. Though still robust, US economic growth continued at a slower pace compared to an annual rate of 4.2% in the previous quarter, as exports slowed amid mounting headwinds from the trade war. The housing market also cooled. Sales of existing houses declined each month and sales of new homes dropped in September to their lowest rate since the end of the Obama administration.
After a difficult October, the US equity market ended November in positive territory amid growing hopes of a trade truce between the US and China. The US equity market was also cheered by comments from US Federal Reserve chairman Jay Powell, who said that interest rates were “just below” estimates of neutral – the level at which monetary policy neither stimulates or restricts economic growth. Markets interpreted the comments as a signal that the central bank is preparing to slow down its interest rate rising programme.
November was another volatile month for technology stocks though, led lower by Apple. Concerns that the company had reached a ‘peak iPhone’ moment began to emerge around the company’s results at the start of the month. It disappointed with its outlook for the critical holiday shopping season and stirred concerns about transparency as it flagged its future plans to stop reporting unit sales of its devices. Concerns that the trade tensions between the US and China could drive down global demand and disrupt supply chains for major technology companies were also renewed, although this pressure was later eased by the aforementioned truce towards the end of November. The share prices of Facebook, Snap and Twitter also fell. Facebook dropped as its public image remained under pressure. Snap and Twitter fell as social media shares were broadly punished.
Economic data released in November remained encouraging and the labour market remained especially strong. US payrolls added 250,000 jobs in October, more than consensus expectations. The US midterm elections were largely as expected with the Democrats taking the House of Representatives while the Republicans held the Senate. This could mean less fiscal support for the economy as Democrats are unlikely to back further tax cuts.
The downward trend continued during December, with the US Federal Reserve announcing an interest rate hike, although a relief rally then occurred once trading resumed after the Christmas break. Wall Street investors cheered upbeat data from Mastercard Inc showing that sales during the US holiday shopping season rose the most in six years in 2018, which helped allay concerns about the health of the US economy.
The chart below highlights the performance of the American Stock Market index S & P 500 over the quarter period to 31st December 2018 and highlights the loss of momentum over the period, after a very strong performance seen earlier in the year.
The S&P 500 closed at a level of 2506.65 on 31st December 2018, falling almost 14% over the Q4 period.

UK Equities

UK Equity markets fell during October, having experienced a period of notable weakness through the middle of the month. The UK market was driven lower along with global markets as concerns around geopolitical factors, such as Brexit and the escalating trade war between the US and China continued. In terms of UK economic data released over the course of the month, September’s headline CPI inflation rate dropped to 2.4% from 2.7% in August, while the core rate (which excludes volatile items such as energy, food and alcohol) fell from 2.1% to 1.9%. UK unemployment remained unchanged at 4% and wage growth accelerated to 3.1%, the fastest pace since January 2009, pointing to steady, if unspectacular, economic growth in the UK. In the Budget the Chancellor stated that the Office for Budget Responsibility forecasts GDP to grow 0.5% in Q3 2018 and 0.4% in Q4 2018, and expects annual GDP growth of 1.3% in 2018 and 1.6% in 2019. On Brexit, the last week of October saw hopes raised of a deal being struck by the end of November after weeks of apparent stalemate.
UK equity markets fell again during November. The decline proved less severe than losses experienced across global markets in October, although negative momentum persisted in to month end. Markets fell amid ongoing geopolitical tension and an accelerated oil price decline. Brexit uncertainty continued to dominate headlines, as the UK and EU’s negotiations reached critical stages. The strength of sterling versus the US dollar and euro continued to act as a barometer for the perceived success of negotiations. The value of the pound fell sharply on heightened fears of a ‘no deal’ scenario but rallied on more constructive news flow. By mid-November, the UK Government succeeded in agreeing a withdrawal agreement with the European Union’s negotiating team, which was later ratified as acceptable by all EU nation states. Sterling’s gains were short lived however, as the Prime Minister suffered a wave of ‘high profile’ resignations from her cabinet and public calls for her to step-down from office, due to the terms of the deal. Sterling ended the month significantly lower against both the US dollar and euro, as market commentators looked ahead to the next stage of the Brexit process, namely the Parliament’s vote on the withdrawal agreement.
Economic data released during the month revealed that the UK economy grew at the fastest rate since 2016 during the third quarter of 2018, despite continued uncertainty around the outcome of Brexit. The Bank of England meanwhile warned that a disorderly exit from the European Union could result in a 10.5% decline in Gross Domestic Product, should a deal fail to be negotiated with the EU. Elsewhere UK house price growth slowed to the lowest pace seen in five years during the third quarter of 2018. UK car production also fell 10% during October – a fifth consecutive month of decline. UK retailers, anticipating a boost from Black Friday, were largely disappointed, as data showed a decline in high street footfall and online sales compared to the same trading period in 2017.
Brexit continued to hold the spotlight in the UK during December. The parliamentary vote on the Brexit deal was postponed and Prime Minister Theresa May survived a ‘no confidence’ vote in her leadership of the Conservative Party. Despite improving wage growth in the UK, the Bank of England left interest rates at their current levels (0.75%) in the face of Brexit uncertainty.
The chart below compares Sterling against the Euro over the month of December. Sterling has been called the Brexit barometer and depreciated significantly against the Euro in June 2016, when the Brexit vote was announced. It is currently trading around the 1.11 Euro mark. When markets feel that the likelihood of a hard Brexit have increased, this tends to weaken Sterling.

The chart below highlights the performance of the UK index FTSE 100 over the quarter period to 31st December 2018 and highlights that market volatility experienced during August 2018. The FTSE 100 closed at a level of 6,728.13.20 on 31st December 2018, falling approximately 10.4% over the Q4 period.

European Equities

In common with other regional equity markets, eurozone shares had a tough October and the MSCI EMU index returned -6.5%. A combination of factors contributed to the weak returns, including tightening global financial conditions, trade concerns, the ongoing dispute over Italy’s budget, and some weaker corporate earnings. Individual stock moves were very volatile over the month, particularly in reaction to earnings announcements. The weakest sectors overall in the eurozone were materials and information technology. Certain IT stocks, such as STMicroelectronics, were among those to deliver disappointing earnings. Telecommunication services was the only sector to post a positive return.
Eurozone equities suffered sharp falls during October, posting the weakest monthly performance in more than six years. Slightly softer macroeconomic data in Europe as well as China and the US, ongoing Italian budget battles, political uncertainty in Germany, Brexit negotiations and a falling oil price all contributed to the weaker market sentiment. Against this backdrop, telecoms performed well and were the only sector to deliver positive returns. Technology and materials sectors suffered the worst falls.
On the economic front, GDP data confirmed a slowdown in the eurozone economy, with a 0.2% quarter-on-quarter growth rate in Q3 compared to 0.4% in Q2. Forward-looking surveys also softened: the flash composite purchasing managers’ index2 for October came in at a 25-month low of 52.7, down from 54.1 in September. As expected, the European Central Bank made no change to monetary policy. It still expected to end net purchases under the asset purchase programme by year-end (which it did) and to keep policy rates unchanged at least until after summer 2019. Italy’s draft 2019 budget was rejected by the European Commission, giving a three-week deadline for Italy to respond with a new draft or potentially face fines. However, ratings agency Moody’s kept the country’s debt rating at investment grade, rather than downgrading to non-investment grade as some had feared. Elsewhere, following a poor result in the Hesse state election, Mrs Merkel announced to her party, the Christian Democratic Union of Germany, that she will not run again as leader at the party convention on 7 December. There was muted market reaction given the fact that she intends to remain as Chancellor until the next election in 2021.
Eurozone equities continued to struggle during November, ending the month lower as investor sentiment continued to be weighed down by political noise – Italian budget as well as Brexit, trade tensions and weaker oil prices. The earnings season in Europe also failed to inspire markets, as November witnessed more earnings misses than hits. Economic data within the eurozone continued to indicate slower growth. The flash composite purchasing managers’ index1 for November came in at 52.4, a 47-month low. Data showed the German economy contracted by 0.2% in the third quarter of 2018, largely due to a trade slowdown as car manufacturers struggled to prove that vehicles met new emissions standards.
The dispute over Italy’s 2019 budget continued during November. The European Commission rejected the draft plans and recommended putting disciplinary procedures in place, which could lead to Italy being fined for non-compliance with budget rules. The Italian Government has vowed to “end poverty” and increase employment, while letting thousands of workers retire earlier, but having previously stood firm on its high-spending plans and risking a stand-off with European Union officials, towards month-end, softened their stance.
Eurozone Economic Growth has been struggling and Annual inflation in Germany slowed sharply in December, marked by a slowdown in energy price rises and pushing the levels below the target of the European Central Bank (ECB). The Federal Statistics Office reported that German consumer prices rose by 1.7% year-on-year (YOY), down from 2.2% YOY the previous month. The ECB targets inflation of close to but below 2% for the eurozone as a whole, with the drop following the end of the central bank’s €2.6 trillion bond-buying scheme earlier in the month. Later in December, the ECB said the global economy was set to slow in 2019 and then to stabilise, but it still expected prices to rise.
The chart below highlights the performance of the European index Euro Stoxx 50 over the quarter period to 31st December 2018 and again highlights the market volatility experienced during October and December 2018. The Index was designed to be a ‘blue chip’ representation of 50 leading companies in the Eurozone. The Euro Stoxx 50 closed at a level of 3001.43 on 31st December 2018, representing a decrease of approximately 11% over the Q4 period.

Japanese Equities

Japan’s equity market also fell sharply as the risk of a global economic downturn increased with the deterioration in investor sentiment in early October. The yen strengthened relative to the US dollar after a period of weakness, reflecting the mixed macroeconomic outlook. The most notable feature of the market environment was the underperformance of many of the growth stocks which have led the market in recent quarters. Value stocks tended to be hit less hard in the market decline which resulted in outperformance from many financial-related sectors, including banks. Growth stocks are those whose earnings are expected to grow at an above-average rate relative to the market. Value stocks tend to trade at a lower price relative to their fundamentals, such as dividends, earnings and sales data.
The Bank of Japan’s regular policy committee meeting in October resulted in no change to monetary policy, as expected. Economic data released during the month was somewhat mixed, with industrial production much weaker than expected, but all recent data needs to be viewed in the context of the natural disasters affecting Japan in recent months. The Bank of Japan’s quarterly Tankan survey showed business sentiment worsened in the third quarter of 2018, both in terms of production and demand, amidst a wave of natural disasters. Heavy rains, flooding, a typhoon and an earthquake disrupted supply chains and suspended production for a number of large manufacturers. As expected, monthly manufacturing surveys weakened and although plans for capital expenditure remain strong, overall domestic economic momentum appeared lacklustre. One surprise was the earlier than expected confirmation that the next increase in consumption tax will go ahead as planned in October 2019.
Japanese Equity markets continued to be volatile in November but a late rally left the Japanese stock market 1.3% higher for the month, with hopes that the US and China would reach a truce over trade relieving concerns about a slowdown in the global economy. There were no strong trends in major currencies, with the yen weakening slightly against the dollar. Sector performance was very mixed. Financial stocks, including banks, underperformed sharply, returning to the relative lows seen in June. Value2 stocks more broadly also underperformed, reversing the upward move seen in the previous month. Markets were somewhat directionless in the first part of the month. There was then a more consistent rally into month-end, as some change was detected in the likely pattern of US interest rate rises. Economic data released in November showed a rebound from the previous month’s weakness, which was largely related to a succession of natural disasters. There were signs that the rate of improvement in the labour market may be peaking. The economy has effectively been operating at full employment for some time, and there is evidence of this flowing through to higher wage growth.
On the corporate front, Nissan grabbed the headlines following the arrest of Carlos Ghosn and his subsequent removal from his position as chairman of the company. Away from the spotlight, however, Japanese companies announced record levels of share buybacks in the wake of their interim results, as the trend towards better shareholder returns continues. A buyback, also known as a share repurchase, is when a company buys its own outstanding shares to reduce the number of shares available on the open market.
In line with other developed markets, Japanese equities continued on a downward trend during December. By Christmas, the Nikkei had retreated to a 20 – month low after a slide on Wall Street deepened on a series of US political developments. US Treasury Secretary, Steven Mnuchin called a meeting of top US Bankers amid the pullback in stock market levels seen in December and said he was calling a meeting of financial regulators to discuss ways to ensure ‘normal market operations’.
The chart below highlights the performance of the Japanese TOPIX index over the quarter period to 28th December 2018 and highlights that downward trend seen in other developed markets, such as the US and Europe, but with some recovery seen just before the New Year. The TOPIX Index closed at a level of 1494.09 on 28th December 2018, representing an approximate 13% decrease in the index level over the quarter period, ion sterling terms.

Asia (Ex Japan) Equities

Equity markets across Asia suffered a sharp sell-off in October as a number of factors dented global investor confidence. A spike in US government bond yields, resurgent dollar strength and escalating trade tensions combined with some soft economic data from China, raising concerns over a slowdown in the global economy, further fuelling investor risk aversion. China’s economy expanded by 6.5% year-on-year in the third quarter, its weakest quarterly growth since the global financial crisis. Industrial production fell in September, though retail sales growth accelerated. The central bank lowered the amount of cash that banks must hold as reserves in a bid to spur growth. Meanwhile, regulators stepped up efforts to bolster market sentiment, including supporting share buybacks and encouraging private equity funds to buy shares in listed firms. Even so, the renminbi slid against the US dollar and Chinese stocks ended the month with double-digit losses. Hong Kong equities also retreated.
In South Korea, concerns over the weakening global economic outlook weighed on its export-oriented economy. The government unveiled fresh measures to revive economic growth and create jobs. Shares in Taiwan were dragged lower by declines in the energy and information technology sectors. Indian equities lost ground as the rupee hit a record low against the US dollar following the Reserve Bank of India’s surprise decision to keep interest rates unchanged. The currency was also hurt by reports of a widening rift between the government and the central bank. In comparison, ASEAN (Association of Southeast Asian Nations) markets such as the Philippines and Indonesia fared better, though they also posted negative returns for the month.
Asia ex Japan equities rebounded in November amid optimism over a more gradual pace of interest rate hikes in the US. Positive corporate earnings news also provided support, while the plunge in crude oil prices boosted net oil importers, such as India. Trade negotiations between the US and China continued to dominate sentiment.
Across the region, Indonesia and India, both major oil importers, recorded the strongest gains as oil prices slumped and their currencies strengthened. The Indonesian rupiah was further buoyed by Bank Indonesia’s surprise interest rate increase to 6%, from 5.75%. Hong Kong and Chinese stocks outperformed the benchmark amid mixed economic data from China. Chinese exports rose 15.6% year-on-year in October, while imports grew 21.4%. Industrial production and fixed-asset investment accelerated, though retail sales growth slowed. The official purchasing managers’ index also missed market expectations in November. Conversely, markets in Malaysia and Thailand retreated. Taiwanese stocks were dragged lower by declines in the healthcare sector and technology heavyweights. Separately, Taiwan’s president resigned as leader of the ruling Democratic Progressive Party following losses in local elections. South Korean stocks also lagged. The Bank of Korea raised its benchmark interest rate by 25 basis points to 1.75%, the first hike in a year, on concerns over capital flight (i.e. investors moving money out of the country), high household debt and Seoul’s property boom. Elsewhere, the Philippine central bank also lifted borrowing rates to rein in rising inflationary pressures.
The total return chart below highlights the performance of the MSCI Asia Pacific index over the 3-month period to 28th December 2018. The Index decreased in sterling terms by approximately 6.4% over the Q4 period.

Emerging Market EM Equities

Emerging markets equities lost value over Q4 in what was another volatile quarter, with US dollar strength and the US-China trade dispute continuing to weigh on investor sentiment and risk appetite, although a falling oil price helped ease the pressure on some emerging economies.
October was a tough month for emerging equity markets, with only Brazil and Qatar posting gains. Undermining market confidence was a spike in global bond yields and further negative headlines on the US-China trade war. Asia was the weakest performing region, led by Korea, Taiwan and China. Sentiment towards the latter was adversely affected by threats of additional US tariffs, whereas Korea and Taiwan suffered from their high weighting of technology stocks in their respective local indices. Although all emerging market sectors fell, technology and healthcare were the laggards.
Latin America stood out as the only region to finish in positive territory. This was down to a strong rally in Brazilian equity markets following the victory of Jair Bolsonaro in the country’s presidential election. Aside from the notable exceptions of the Brazilian real and Turkish lira, most other emerging market currencies declined in value versus the US dollar. Brent Oil prices fell towards US$75 a barrel over the month, industrial metals were broadly down 5% and copper sold off on global growth concerns. While equity markets in Brazil reacted favourably to the Bolsonaro election victory – in anticipation of pro-market reforms – Mexico’s decision to cancel the partially built airport in New Mexico City was not warmly welcomed. As a result, Mexico was the biggest drag on equity performance in Latin America, with October being the country’s worst month since the global financial crisis. Confidence was also knocked by fears that interest rates could rise further due to persistent inflation.
By contrast, all sectors in Brazil posted double-digit gains, with energy leading the pack. Equity markets lost ground in the EMEA (Europe, Middle East and Africa) region, with South Africa being the laggard. Although economic data from the latter was broadly positive – retail sales for August comfortably beat consensus expectations – overall performance was dragged down by index heavyweight Naspers (down 18.5% in local currency terms). Similarly, upbeat data on the Russian economy – industrial production up and unemployment down – couldn’t stop a slide in local equity prices, with oil and gas companies losing appeal from weaker energy prices. The easing of tensions between Turkey and the US following the release of American pastor Andrew Brunson provided lift to the lira currency and also helped to limit losses on the equity front.
Global emerging equity markets overcame initial weakness to finish the month of November in positive territory. The advance gained momentum during the last week of November, following less aggressive words surrounding interest rate rises from the US Federal Reserve (Fed) Chairman Jerome Powell. In particular, markets took note of Powell’s comments that US interest rates are “just below” neutral, a shift from previous observations. This ignited debate that the end of the US interest rate hiking cycle was nearing and called into question whether the Fed would still press ahead next year with a series of interest rate increases that had previously been forecast. The US dollar lost ground against a basket of emerging market currencies, with the Turkish lira and South African rand appreciating strongly. In terms of equity performance, Asia came out on top, with gains here being led by Indonesia and India. Optimism of a temporary truce in the US-China trade war ahead of the G20 meeting in Argentina provided a boost to equities in China. In a positive development, the leaders of the world’s two largest economies did come to an agreement to pause the tariff war, with the US holding off plans (for 90 days at least) to increase duties from 10% to 25% on US$200bn worth of Chinese imports.
Elsewhere, the EMEA (Europe, Middle East and Africa) region recorded positive equity returns, with Turkey leading the pack. By contrast, Latin America was the only region to decline in November. From a sector perspective, real estate was the leader in emerging equity markets, with energy being the laggard. Sentiment towards the latter was adversely affected by the collapse in oil prices – Brent crude lost more than 20% in value, its worst month since the global financial crisis. Hungary and Poland led the equity rally in emerging Europe with uncertainties over the Italian budget and Brexit having little, if any impact. Likewise, falling oil prices and rising geopolitical tensions with Ukraine did not have much bearing on Russian equities, although they did close marginally lower, with telecoms, not energy, being the weakest sector. Fading political tensions in Turkey and better news on the inflation front (Consumer Price Index inflation slowed last month from a 15-year high in October, dropping to 21.6% from 25.2%) bolstered the country’s equity market, especially financials. An interest-rate hike to 1.75% from 1.5% in the Czech Republic did not derail an upswing in local equity prices. Interest rates were also increased in Mexico, rising to 8.0% from 7.75%. Although this decision was expected, a statement released from the central bank left the door open for further interest rate hikes. Sentiment towards Mexico was also hurt by concerns over monetary policy uncertainty ahead of Andres Manuel Lopez Obrador taking office as president of the country. Equity markets in Brazil generated disappointing returns, with political events dominating the headlines as president-elect Jair Bolsonaro drew up plans to fill key cabinet posts, including that of a new finance minister.
The final trading day of 2018 was dominated by the plight of the Chinese economy, with the release of mixed Purchasing Managers PMI surveys accompanied by positive shifts in the rhetoric surrounding trade talks with the US. 2018 has been dominated by the breakdown in trade relations between the US and China, spurring widespread selling in Chinese stocks. With the Chinese CSI 300 index falling 25% over the course of the year, the index is the biggest loser of 2018; however, some commentators believe that we are on the cusp of a major breakthrough in global trade, with both the Chinese and US pronouncing their optimism over the direction of talks.
The chart below highlights the performance of the MSCI Emerging Markets (GBP) index over the 3-month period to 28th December 2018 and highlights the volatility experienced in Emerging Markets during October 2018, but with some respite and recovery made in November. The Index decreased in sterling terms on a total return basis by approximately 5.1% over the Q4 period.

It is however important for the long term investor to keep these shorter term market movements into perspective and the following corresponding chart over a 10 year period, highlights the magnitude of the falls in Emerging Market equities over 2018, against the backdrop of the longer term returns.

The Bond Markets

The story of government bonds through 2018 has largely been a story of strengthening US economic growth and rising rates in the US, versus country specific, often political factors, elsewhere in the world.
The trend in Q4 2018 as seen in the following chart has been one of rising government bond yields. Bond Yields rise when bond prices fall. Bond prices fall when there is less investor demand to buy such bonds, reflecting a more risk on sentiment by traders in the investment markets.

Source: Schroders – total return data for 10-year UK, US, German and Japanese government bonds correct at 19 December 2018. Data rebased to 100 to provide an easier comparison.
Strong growth, wage inflation, rate hikes in the US and a seemingly more hawkish Federal Reserve chair all contributed to persistent upward pressure on yields. The significant 3% yield level was broken in September. It remained above that level until early-December when risk aversion returned.
In Europe, the key stories were the slowdown in economic growth and the victory for populist parties in Italy, who subsequently formed a coalition government. This resulted in 10-year Bund yields falling from 0.42% to 0.31%, even as the European Central Bank announced the end of monetary stimulus. Italian 10-year bond yields rose from 2.00% to 3.21% when the coalition government announced a proposed budget which led to friction with the EU. Italy has now reached agreement with the EU which keeps it out of the “excessive deficit procedure”, where the EU monitors a country’s debt. Italian bond yields have fallen since, but still remain elevated.
UK 10- year gilt yields reached a peak of 1.73% in early October falling back down to 1.28% by the end of 2018. The overall driver was continued above-target inflation, a consequence of weak sterling following the Brexit referendum, and expectations of interest rate hikes. The Bank of England increased rates in August, but kept rates on hold December. The relationship between bond yields and Brexit news has not always been clear; however, the 10-year yield declined immediately following the announcement of the draft Brexit withdrawal agreement on 14 November.
In the global bond markets, Corporate bonds on the whole saw further negative total returns during November and underperformed government bonds as risk sentiment remained subdued. Local currency Emerging Market Bonds performed well as the US dollar softened and various currencies, notably Turkish lira, Indonesian rupiah and South African rand, rallied. The Indian rupee performed well, benefiting from the decline in the oil price.
The global bond sector faired better in December as prices recovered to some extent following the price falls seen earlier in October and November. The chart below reflects December recovery and shows the sector average total returns over 2018 for all the UK unit trusts and open- ended investment companies operating in the Investment Association Global Bond sector.

Commercial Property

The Q3 2018 RICS UK Commercial Property Market Survey results point to a fairly subdued trend across the occupier market, with respondents citing Brexit uncertainty as weighing on occupier decisions to a certain extent. That said, structural changes continue to pose the most significant near term challenge for retailers, while on the flipside, conditions within the industrial segment continue to benefit from the shift towards online shopping. The retail sector continues to exhibit negative rental projections across all parts of the UK, with respondents anticipating a downward trend in prime locations as well as for secondary. The outlook is relatively flat for prime office rents in the capital, but more positive across all other UK regions. The industrial sector remains the outperformer in terms of rental growth expectations in all areas, although, in some cases, forecasts have been trimmed slightly
UK property shares fell in tandem with the sell-off in global equity markets in October. Sentiment was roiled by a recurring litany of worries, including the pace of US interest rate hikes, and the widening trade rift between Washington and Beijing. Industrials and technology were among the worst performers, while the oil-and-gas sector retreated in line with falling crude prices. In economic news, UK GDP expanded at a faster than expected rate of 0.6% in the third-quarter and Consumer Price Inflation of 2.4% was slightly lower. Nonetheless despite this, and UK unemployment of 4% at a record low of the last forty years, consumer spending in high street stores remained in negative territory continuing the current declines affecting rents and capital values for shops.
Despite Brexit uncertainty, the industrial sector has attracted plenty of attention from investors. Q4 2018 data for UK commercial property is not yet available, but it will be interesting to see if investors have deferred property investment decisions, pending the Brexit deadline of 30th March 2019.
Burton & Fisher continue to support our specialist property fund managers, who we feel can identify those opportunities ahead. These now include commercial property opportunities overseas as we have recently extended our range of specialist funds available.

Commodities

Commodities are often seen as a bellwether for the global economy. If the prices of commodities such as oil and copper are rising, then it could be taken that investors see a more robust economic outlook. However, if they are falling and gold is rising, then investors are seen to be more cautious.
Commodities such as oil and copper are fundamental to a thriving economy. Oil is used in the production of goods and services, while copper is used throughout the construction of buildings and houses. If the demand for construction is strong, so too should be the demand for oil and copper. If the reverse is true then investors tend to put their money into gold because gold is a physical asset, more easily converted into cash and seen as protection against inflation.
As the chart below shows, while oil and copper have fallen, gold has largely retained its value over the Q4 period.

Source: Schroders – data for the Crude-Oil WTI, Gold Bullion and LME-Copper as at 19 December 2018.
The following chart highlights the rise and fall in the oil price this year, with Brent Crude currently trading at around 55$ per barrel.

Commodities (continued)

Oil prices fell during October, pushed down by news that Saudi Arabia (the world’s largest crude exporter) would max out its supply capacity to meet global demand. Oil prices have drifted down in response to this notable change in policy and this has an impact on energy stocks held within portfolios, but can spell better news for emerging market oil importers, such as India.
Oil price weakness continued during November due to a combination of factors ranging from global growth fears to Iranian sanction waivers. Iranian sanctions imposed by the US earlier in November initially triggered further fears about the global oil supply, and Saudi Arabia promptly promised to increase production. However, unexpectedly lenient sanctions waivers for Iran’s customers, a pickup in energy supply elsewhere (oil from cash-strapped Libya and shale from the US), and fears about the global growth outlook combined to take the oil price lower. Some of this price weakness was also due to the unwinding of existing market positions, as investors have been broadly positive about oil for some time. Some forecasters see these overall price moves as disproportionately large versus oil market fundamentals, meaning that energy markets could rebound ahead.
In early December, oil markets did receive a welcome reprieve following a very challenging November, as Russia and Saudi Arabia agreed to extend their market-managing pact into 2019. This was compounded by Canada’s largest oil producing province (Alberta) announcing plans to curtail production, aiming to push up prices for its prime export. All of this points to potentially tighter oil supply ahead and as a consequence a higher oil price. Even the news that Qatar had decided to leave OPEC (the Organization of Petroleum Exporting Countries) left markets unmoved – Qatar is responsible for only around 2% of global oil production, and the decision reflects regional rather than energy market tensions.
Part of the problem facing global markets and commodities is the continued strength of the US dollar. It hurts commodities in particular because they are priced in dollars. A strong US dollar means commodities become more expensive because of the exchange rate.

Another issue is that a lot of the world’s debt, both company and government, is borrowed in US dollars. Again, a strong US dollar means that for foreign borrowers, debt becomes more expensive to repay, which hurts company profits and increases government deficits. This is because in local terms they will owe more money as a result. However, the inversion of the yield curve In December, where the Yield on 3 year US Treasury Bonds, fell below the Yield on 5 year Treasury Bonds, suggested that investors were speculating that the pace of US growth and the pace of future US interest rate rises could slow, which would affect the value of the dollar downwards during 2019.

Burton & Fisher Model Portfolios
Given the continued backdrop of volatility in the markets over Q4, it is important to have a spread of investments to minimise the investment risk and our model portfolios are constructed in order to give access to a wide range of leading fund managers operating in the different sectors around the world. Typically, our portfolios consist of 15 or more collective investment funds and each fund is monitored on a regular basis, in particular to assess the continued suitability of each fund. This entails monitoring the investment performance and volatility of each active fund, in order to assess that they remain competitive and have that potential to enhance longer term returns.
For example, the cumulative performance of the Burton & Fisher model portfolio 5 over the five- year period to 31st December 2018 is shown below. The portfolio is suitable for a person with a low medium investment risk profile. Whilst not insulated from the recent volatility in markets, the portfolio has made a respectable return and has outpaced sectors average over period shown. The FTSE 100 index, which consists of many international companies is also shown for comparison.

Unless specified otherwise, the performance figures shown in this report are supplied by FE Analytics and only serve to show how the portfolio and wider markets have performed in the past. The past performance data above is based solely on the current allocation of funds and does not reflect changes in funds and allocation over time. Past Performance is not a reliable indicator of future results and the value of investments is not guaranteed and may go up or down. Returns shown above are after fund management charges, but before financial advice and product charges, other charges and taxes where relevant. Price total return performance figures are calculated on a bid price to bid price basis (mid to mid for OEICs) with net income (dividends) reinvested. Performance figures are shown in Sterling unless specified otherwise

Asset Allocation

Asset Allocation is based on long-established and well-proven mathematical principles, it involves achieving the correct balance of assets in your portfolio. The universe of investment funds available for you to invest into are categorised under different asset classes depending on their particular focus. Different types of assets have different performance characteristics, so it is very important to allocate the right mixture of funds to your portfolio so that, over time, the peaks and troughs of their performance balance each other out meeting your particular risk and reward expectations.
Burton and Fisher reviews the asset allocation for our clients on a quarterly basis, any changes that we are recommending to the rebalancing of your investment strategy will be communicated to you for your approval. Given the recent volatility in the markets, we are monitoring events closely and will communicate any significant tactical changes to portfolio allocations as part of our ongoing review service.
The current asset allocation of the Burton & Fisher Model 5 portfolio is shown in the chart below.

Source: Dynamic Planner 31.12.2018

Important Information

Burton & Fisher Financial Services is authorised and regulated by the Financial Conduct Authority (FCA) in the conduct of investment business. This document is not investment research and you should not treat this guide as a recommendation to buy, sell or trade in any of the investments, sectors or asset classes mentioned. Some of the market commentary has been provided by a selection of our preferred fund managers.
The value of any investment and the income from it is not guaranteed and can fall as well as rise, so that you may not get back the amount originally invested. Past performance is not a reliable indicator of future results.