2019/05/23 00:00:00

After the sharp losses suffered at the end of 2018, investors were able to take heart in the first quarter (Q1) of 2019 with markets rebounding as a few negative factors appeared to reverse themselves. Although evidence of slowing global growth continued to mount, global equities and bonds rallied strongly after the US Federal Reserve announced a substantial change of view and decided to pause (and perhaps even end) its interest rate hiking cycle. At the same time, other developed market central banks undertook more growth-supportive moves, and considerable progress was reportedly made in resolving the US-China trade dispute. On the negative side, an even more chaotic Brexit environment and the uncertainty engendered by Trump's unpredictability remained bearish factors for markets. Emerging markets also benefitted from the more bullish sentiment and the Fed's rate pause, but some like Turkey and Venezuela faced idiosyncratic challenges.
In the US, it was the Fed's more dovish rate stance that proved to be the key for turning last year's losses into this quarter's gains. The Bank emphasized that it would be 'patient' when it came to further raising interest rates, given that the case for hiking had weakened in the face of slowing global and US growth. This eased fears that inexorably higher rates could choke off growth. US GDP growth for Q4 2018 was revised down to 2.2% (q/q annualised) from 2.6% previously, sharply lower than the 3.4% in Q3 2018. Dismal US retail sales data were a key highlight. Not only did the Fed opt to keep rates on hold at its January and March FOMC meetings, but on 20 March its 'dot plot' showed it had slashed its own interest rate expectations from two 25bp rate hikes in 2019 to zero, and only one 25bp hike in 2020. This was very positive for equities, and also helped push longer-dated US Treasury bond yields lower, such that the yield curve 'inverted' for the first time since 2007 (where 3-month interest rates were higher than those for 10-year bonds). Some interpreted this as a sign of a looming recession.
Adding to the general positive news was the end of the 35-day US government shutdown in January, and that good progress was reportedly being made in the US-China trade negotiations to avert higher tariffs and a full-blown trade war. This was particularly beneficial for the global growth outlook, especially for trade-dependent countries like China, Japan and South Korea, and helped push the US dollar stronger for the quarter against most other currencies (although not the yen). For the quarter, the US S&P 500 returned 13.6%, the Nasdaq 16.9% and the Dow Jones Industrial 11.8%.
In the UK, agreement was reached with the EU to extend the Brexit deadline into April, and PM Theresa May effectively lost control over determining a way forward, forced to hand over to Parliament. However, MPs rejected every possible option for structuring the future relationship, worsening the chaos within government. Meanwhile, UK GDP growth slowed to 1.4% (q/q annualised) in Q4 2018 from 1.6% previously, with the EU area equally pedestrian at 1.4% for the quarter. This deteriorating growth was a factor in keeping interest rates on hold across both regions, as well as in the US Fed's interest rate view. The European Central Bank even introduced a new cheap long-term loan plan for banks to help avoid further deceleration, as Germany's manufacturing data was negative for three months in a row. The UK's FTSE 100 returned 11.6% for the quarter, while the Dow Jones Eurostoxx 50 produced 10.2% (both in US$).
During the quarter it was revealed that the Japanese economy returned to growth in Q4 2018 after a contraction in Q3, although exports remained sluggish amid trade uncertainty and the slowdown in Chinese growth. Japanese GDP is forecast to reach around 1.0% in 2019, supported by the Bank of Japan's ongoing easy monetary policy, but expected to be hit by a new consumption tax on spending and consumer prices to take effect later in 2019. For Q1, the Nikkei 225 returned 6.5% in US$. In China, meanwhile, 2018 GDP growth came in at 6.6%, its weakest in 28 years but meeting consensus expectations. The government's new 2019 growth target is even lower at 6.0%-6.5%. There was, however, renewed optimism amid the positive US-China trade news; government pro-growth measures, including easier bank credit, took effect; and manufacturing activity accelerated - China's PMI recorded its highest rise since 2012. This helped the MSCI China post a return of 17.7%, making it the best performing large emerging market in Q1.
Among other emerging markets, strong performers for the quarter included the MSCI Russia with 12.2% and Brazil's Bovespa at 8.0%. The weakest markets were the MSCI Turkey (-3.0%), South Korea's KOSPI 200 (3.4%) and the MSCI South Africa (4.6%), all in US$.
The price of Brent crude oil recovered sharply in Q1 2019 to gain 27%, ending March at around US$67 per barrel. This was attributable to additional sanctions on Iran being considered by the US and a halt in operations from a key Venezuelan export terminal. Looking at other commodities, gold gained 0.8%, palladium was up 9.5% and platinum rose 6.8% for the three months. Industrial metals prices were broadly higher, especially nickel (21.6%) and zinc (19.1%).
Despite US dollar strength, the rand lost only 0.5% versus the greenback, but 2.1% against the UK pound sterling, while gaining 1.3% against the euro, which was hit by growth concerns and more dovish interest rate expectations.
PERFORMANCE
The fund produced a return of 11.2% (net of fees) for the first quarter of 2019, underperforming its benchmark by 1.6%. For the year ended 31 March 2019, the fund returned 19.4% (net of fees), underperforming its benchmark by 5.8%. Detracting from relative performance were underweight positions in US equities and overweight position in Financials globally.
STRATEGY AND POSITIONING
So far in 2019 we have seen an unwinding of the exaggerated risk aversion that took hold in late 2018, although this may not continue. At the moment, the most compelling opportunities still appear to be in cheaper equities where the market remains sceptical on global growth.
In terms of trades over the period, we reduced the fund's exposure to Korean equities by a modest amount, and increased China equity exposure via an ETF holding.
While we continue to see low inflation rates in both developed and emerging markets, and strong employment levels - with wage growth also starting to pick up - there has been weak data from a trade and manufacturing perspective. The easing of pressure from rising interest rates coming from the Fed - and other central banks - is likely to be a major driving force for markets prospectively. In this regard, we will continue to monitor changes in the fundamentals and prevailing equity valuations when deciding how to best position the fund in the future.