Market insights

15 May 2018

If we were pressed to choose a word to represent the first quarter of 2018, it would be ‘volatile’. The steady and prolonged climb of the stock market led some investors to believe that this winning streak would only continue. History, however, told us that an environment without jitters is the exception, not the rule. Entering the new year, we anticipated that the stock market would be ‘positive but bumpier’. The expectation was for increased periods of instability, yet the reality was much poorer than predicted.

Time to take stock

Following the strongest January in three decades, stocks posted their worst February for nine years, prompting us to examine new ways of forecasting political outcomes and how to deal with increased volatility in our Compass Q2 2018 report.

If the headlines were to be believed, doomsday had been and gone, with hasty comparisons to previous stock market crashes made by journalists and pundits reaching for headlines and airtime. What’s important to remember, though, is that many of the daily micro and macro political developments do not affect the fundamentals of our economy.

Reacting to short-term news with frequent portfolio repositioning can have significant financial and emotional costs. High transaction fees for frequent trading can erode returns over time. Similarly, an investor tendency to hold faltering positions longer than winning ones often leads to a portfolio of losers.

Our advice? Be prepared. It’s important to plan for how you would weather a storm in the stock market with a focus on your long-term investment strategy, and not the anxiety-inducing headlines foreshadowing the end of the financial world as we know it. By ensuring you are well-positioned to withstand frequent bouts of volatility, you should be better-equipped to control your circumstances against a backdrop of ever-changing investor sentiment.

Government control and the wider world

Bigger in impact than our own behavioural tendencies, however, are the wide-reaching (and somewhat untouchable) measures to protect the economy at a governmental level.  We’ve relied heavily on constitutional safeguards for many years, the faith in which has been duly rewarded in much of Europe. The US, by contrast, paints a very different picture.

Congress – in place to counter the whims of an over-reaching or incompetent executive – have recently passed a much-debated budget agreement. In the short run, US growth is expected to rise – but at what cost? The agreement will increase total outlays by $400bn over the next 10 years. Combined with the tax cut for US households and corporations – expected to add an estimated $1.5trn to the deficit over the same period – it is not difficult to see where the dangers lie.

In the medium-term, there is a growing risk of inflation that would further complicate the already challenging task of normalising monetary policy in the world’s most important capitalist economy. As it stands, inflation remains contained, but it is rising; this leads us to be tactically wary of high quality government bonds in spite of the correction already seen this year.

We are equally wary of the potential for a US policy misstep, whether fiscal or trade-related. The safeguarding capabilities of government branches are, after all, only as good as the people serving within them. Despite our concerns, lead indicators are still signalling growth ahead for the major economies, and we remain positioned to take advantage with our base outlook: that stocks will outperform bonds this year.

Regulation and greater transparency

In parallel to our belief that the world economy will continue to grow, is our conviction that the cycle end is a relatively distant prospect. We still see investors being best-served by leaning portfolios towards developed equities, and Continental Europe in particular. What’s more, the new regulatory framework introduced earlier this year – the second ‘Markets in Financial Instruments Directive’ (MiFID II) – looks set to further enhance the knowledge and insight of our manager and fund selection team, leading to improved investment decisions going forward.

The new rules – 1.4 million paragraphs worth – essentially require all trades to be reported in detail and in a timely manner. The explicit disclosure of trading costs, the removal of soft commission so that all research must be paid for, and the regulations to ensure that funds continue to be suitable for the clients they are sold to, are all set to increase transparency and protection for investors. Decreased volatility, you might say.

To obtain a copy of the Compass Q2 2018 report or to discuss investment opportunities, please contact your Private Banker. Please also see our Investment Services overview on the Private Banking website.

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