Some markets are provocatively low, says analyst
Higher inflation benefits companies with pricing power, and some markets are well positioned for a strong recovery, with a weaker dollar helping the emerging markets
2018 has been a disappointing year for most investors. Almost all markets, both stocks and bonds, have fallen in value last year, under pressure from rising interest rates, political developments such as Brexit, and the trade dispute between the US and China. With hindsight, markets were priced for perfection at the start of 2018 and were vulnerable to bad news - and there has been plenty of that.
It is easy to be influenced by the pessimism now affecting markets. We accept that there is likely to be more bad news in 2019 - and I would pick out the trade dispute between the US and China as showing no sign of resolution and with the potential to damage economic growth around the world. But there are signs that market returns may be more positive in 2019.
Greater realism has arrived with falls in stock markets, particularly since September last year. Markets are pricing in at least some of the risks we have identified.
Schroders' economists expect a gradual slowdown in growth in the US in 2019 and 2020. The emphasis is on the word gradual: we do not see a recession as likely in 2019 (although not inconceivable in 2020) as many of the forces that led to a strong year in the US in 2018 are still in play. The slowdown, however, means that an end to the cycle of rising interest rates is in sight. If we are right that interest rates rise no further than 3%, that is a modest peak compared to past economic cycles.
Our equity fund managers all point to slightly higher inflation this year as helpful to those companies that have strong market positions and the ability to raise prices. They also see more attractive valuations for many companies. Even in Europe and the UK, where growth has been disappointing, the income return from dividends alone looks more attractive compared to cash or bonds than for some time. Equities do, of course, carry greater risk along with potential for higher returns though.
Weaker growth in the US is also likely to lead to the US dollar losing ground against other currencies. This is good news for emerging stock and bond markets as a strong dollar sucks money away from these markets. Emerging markets, including China, have suffered particularly badly in 2018 and we would not be surprised to see them recover in 2019. Our multi-asset team describes their valuation as "provocatively low".
Our bond managers are not so comfortable about the outlook, with the central banks, who have been huge buyers of government and other bonds, steadily departing the field. Corporate bonds, however, have become cheaper in recent months and, if we are right about a limited slowdown in the US this year, will be supported by strong fundamentals.
2018 was the year in which the long-term sustainability of business models started to influence how the market prices companies. We have seen criticism of some practices of large technology companies leading to falls in their stock prices, and increasing physical damage caused by climate change. Inequality between generations has led to political turmoil in several European countries. Across our investment decision-making an eye on sustainability is becoming more and more critical.
Our recent report highlighted the modest return prospects from public markets, given lower rates of economic growth than in the past and the low level of bond yields. 2019 will fit that pattern, with positive returns likely, but investors having to work hard - both through asset allocation and security selection - to augment low headline market returns.
I also continue to believe that private assets such as private equity and real estate will, as part of a diversified portfolio, help investors achieve their goals.
Peter Harrison, group chief executive, Schroders
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10 Jan 2019