Investment themes for 2019

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Graham Smith - Market Commentator

2 January 2019

As we enter another year, there is nothing much new about the economic challenges that lie ahead. Unresolved matters include Britain’s biggest economic and political adjustment in two generations, uncertainty about world economic growth and how quickly US interest rates might move up.

While this outlook may urge a cautious investment approach, it’s also worth remembering that such uncertainty has often ushered in more positive periods for stock markets. The depths of the global financial crisis in late 2008 and early 2009 were the best and worst of times, for fears of a world depression coincided with the best market entry points for investors in many years.  

While we are clearly at a different and more advanced stage in the economic cycle today, it remains true that the handmaiden of uncertainty is opportunity. When investing feels most difficult, markets and shares are likely to be reflecting the uncertainty we feel in depressed buying prices.

We’ve mentioned it quite often over the past few months, but it’s worth repeating: The host of worries converging on the UK stock market right now have helped to push dividend yields firmly into attractive territory.

Compared with history, a dividend yield of around 4.5% for the FTSE All-Share Index, and of more than 6% for a good number of blue chip household names, seems to offer good compensation for waiting for better times1.

Many very high quality companies – and those expected to do well in an unpredictable environment, in other words – yield less than this, although the discount understood to be bearing down on UK equities generally means they too may be offering good value.

So focusing on value this year may prove to be no bad thing. Once economic and political matters begin to be resolved, stocks displaying solid fundamentals and high and sustainable dividends may find more friends.

2018 had a lot to do with capturing the bow wave of growth in America. With the substantial tailwind of a US$1.5 trillion tax cut, still low interest rates and booming consumer confidence, the US stock market was able to build a broad performance gap – at least for a while – between itself and the rest of the world2.

Now, concerns that the strong growth we have already seen will not last are nagging investors. What’s niggling markets most is the fact that there is now little difference between US interest rates – which rose to an effective 2.4% last year – and the amounts paid out in percentage terms on two-year and 10-year US government bonds3.

If you think about it, investments requiring investors to commit cash for 10 years should pay a premium return over cash, as a reward for accepting the risks that could emerge over that period as well as the cumulative, negative effects of inflation.

That they do not implies markets expect very little inflation over the next 10 years and, also by implication, very little economic growth – the two tend to go hand in hand.

That seems overly pessimistic in view of economic growth in the third quarter of last year of 3.5%4. Even as interest rates head back to a level considered neutral for economic growth, and the stimulus of the Trump administration’s tax cuts begins to fade, it’s hard to envisage growth and inflation falling close to zero in the near future.

Another way of looking at this conundrum is in terms of the safety aspect of government bonds in general. It could be that investors are holding longer term bonds as a defensive measure against further bouts of stock market volatility.

In so doing, they may be accepting low yields today in exchange for the possibility of capital gains later, when the US economic expansion does finally come to an end. Time, as always, will tell.

By comparison with the US, major international stock markets trade on lower ratings5. Yet reasons for optimism accompany the risks. Emerging markets look good value after last year’s falls, despite their apparent resilience to potentially contagious events in countries like Argentina and Turkey. International trade concerns and China’s economic slowdown are also likely, at least in large part, to have been discounted in current prices.

Unresolved matters in Europe include continuing political risks in Italy, while sub-par inflation and a further planned rise in consumption tax this October in Japan remain concerns. However, both regions continue to benefit from key interest rates below zero and healthy rises in corporate earnings.

One thing we can be more certain of is that longer term demographic and technology driven themes will press on regardless. For example, with the treatment of customer data increasingly under scrutiny, global social media companies may be entering a period where investors are consistently more wary of them.

Equally, with true innovation in smartphones thin on the ground over the past couple of years – bigger or smaller or clearer screens don’t really cut it anymore – a real leap forward may be needed to convince consumers to upgrade. A foldable smartphone – which flattens out to a tablet-size display – emerged towards the end of last year and might be it6.

Digital pills, the first one of which was cleared for use in the US just over a year ago, could eventually transform the healthcare industry. The potential benefits of pills able to monitor and send back data about the health of their users, dosages and to combat addiction could be genuinely world changing7.

Pursuing themes like these in 2019 could take investors down paths favouring innovative, fast growing companies – so the opposite end of the spectrum to where we came in, with value stocks. In 2019 again then, building a broad spread of investments encompassing best-of-breed companies of both types would seem to be a sensible way to go.

Funds typifying active, growth oriented management styles on Fidelity’s Select 50 list of favourite funds include the Rathbone Global Opportunities Fund and, closer to home, the LF Lindsell Train UK Equity Fund . Value oriented investors may find another Select 50 choice – the Fidelity Special Situations Fund – more to their liking.

Given the range of uncertainties currently facing markets, a balanced investment approach – one that encompasses an exposure to bonds as well as a broad range of equities – also looks advisable. The soon-to-be-one-year-old Fidelity Select 50 Balanced Fund has already proven its worth in challenging market conditions and could have the opportunity to do so again in 2019.

Sources:

1 FTSE Russell, 30.11.18, and Bloomberg, 02.01.19

2 FTSE Russell, 05.09.18

3 Federal Reserve Bank of St. Louis, 31.12.18, and Bloomberg, 02.01.19

4 Bureau of Economic Analysis, 28.11.18

5 Bloomberg, 02.01.19, and MSCI, 30.11.18

6 BBC News, 07.11.18

7 The Pharmaceutical Journal, 16.11.17

Important Information

The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Select 50 is not a personal recommendation to buy or sell a fund. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.