New year, same issues?

Leigh Himsworth

Leigh Himsworth - Portfolio Manager, Fidelity UK Opportunities Fund

6 December 2018

There are a range of factors to watch as we move towards and into 2019. The strength of the US economy will determine the path of US monetary policy - further strength will indicate more interest rate rises and so continuing volatility in markets across the world.

This has been a key driver in 2018 and one that looks set to continue over 2019. The lag between a move in interest rates and the impact on the economy may mean that we begin to see a slowing US economy as we progress through 2019, although we are likely to see pockets of strength from the fiscal stimulus and the more ‘patchy’ and perhaps less predictable impact of tariffs.

A further surprise in 2018 has been the price of oil, which has exceeded most analysts’ forecasts and has been a factor in elevating expectations of inflation. With low levels of unemployment and wage pressure, it is difficult to see a volte-face by the Federal Reserve to monetary stimulus in 2019.

Such factors mean that we will see an emphasis on individual company earnings to drive shares forward. As US 10 year yields sit above 3%, earnings growth must be strong to justify the perceived added risk of investing in equities.

New horizons for the UK

Stock markets hate uncertainty as it is difficult to plan for a reasonable time horizon. For me, the best outcome for 2019 is to leave behind the uncertainty of Brexit and to determine the new path that the UK will follow. This will allow companies to plan and invest and for consumers and the workforce to see, and perhaps believe in this.

Clarity will allow companies to determine their new terms-of-trade, perhaps identifying any restrictions, tariffs or new legislative environment and, maybe, seeing new and exciting markets that may present themselves.

A problem that equity markets may begin to anticipate, if not beginning to already, is the fact that US monetary tightening is likely to begin dampening demand through 2019. This may weaken the outlook for earnings at the same time as a relatively strong dollar may hurt exports, as may trade tariffs.

Whilst a weaker dollar may give some respite to emerging markets, a weaker economic outlook in the US will cause a headache. During the financial crisis it was relatively inexpensive to inject massive monetary stimulus into the economy as yields were exceptionally low and the curve flat. But as the yield curve has now shifted upwards such stimulus would be far costlier, in addition to funding the now massive total level of outstanding debt.

Where are the ‘banana skins’ in 2019?

As always, in uncertain times the first step is to ensure the portfolio is well diversified and balanced. For me, this means that the Fidelity UK Opportunities Fund does not take a significant sector stance. If there is a significant overweight position this is usually due to favouring a handful of individual ideas that happen to be from the same sector.

A second step is to make sure we know our companies well and quickly grasp any unexpected market movements, perhaps using market volatility to add to high conviction positions. The focus remains on holding roughly 50 high conviction positions that are relatively evenly weighted.

As investors may start to see the need to seek growth for returns - but may be reluctant to pay a premium for this - we may see a return of ‘GARP,’ or Growth At a Reasonable Price, again as a core strategy. Value may not necessarily be the answer as inflation and yields may remain elevated and so it may be essential to retain some stocks with exciting growth potential. Seeking out such growth tends to mean that the focus is on the mid-tier companies - those that are growing quickly yet have a mature infrastructure, a strong management team and positive cash generation.

A further step is that having identified some potential ‘banana-skins’ for 2019, that the portfolio has some insulation against these and the likely heightened levels of volatility that we may experience. Some oil stocks will be vital, defensive positions, commodity exposure, as well as some more exciting smaller growth stocks.

As the direction of bond yields may be less clear the macro tilt within the fund is likely to have less significance. There is a greater chance that the ‘special situation/market anomaly’ section of the portfolio may have a greater role to play in 2019, although overall there is more balance and a greater emphasis on core stock positions.

In the latest edition of MoneyTalk, Leigh shares his outlook for the UK in 2019.

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. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. 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.