Stock markets around the world

UK

For investors in the UK stock market there is light at the end of the tunnel. One way or another the Brexit uncertainty that has hung like a millstone around investors’ necks will be resolved in 2019. This will be a welcome relief to all.

For many businesses, it really doesn’t matter whether Britain is in or out of the EU. For others they will have to adapt to new circumstances but they will do so. What will benefit all listed companies in the UK is the end of the Brexit discount which has seen shares sold down indiscriminately.

The valuation of the UK market has reached a level that must surely be attractive to anyone investing over the medium to long term. Of course, no-one has any idea what the next six months holds, and it is entirely possible that UK shares and the pound could fall further. But on a three-to-five-year view this looks like a good entry point.

The FTSE 100 currently yields around 4.5%. This compares with 10-year government bonds offering a yield of less than 1.5% and interest rates at just 0.75%. The average FTSE 100 share costs just 11 times expected earnings. Both measures are attractive.

For stock-pickers, the opportunities are plentiful. Within the FTSE 100, 18 companies currently yield more than 6%, a further 11 offer an income of 5% or better. Another 13 yield more than 4%. Of course, not all of these dividends will be paid but some simple caveats like checking whether the payouts are adequately covered by expected earnings will highlight the obvious problems.

The price you pay at the time you invest is the most important driver of your eventual return and it is a fact of investment life that the opportunity to secure really attractive prices only ever comes when the outlook is bleak, or very uncertain anyway.
Back in 1992 when the pound crashed out of Europe’s exchange rate mechanism and Britain was emerging from the recent recession, investing in the UK market did not seem like a great idea. But look back on the past 25 years and you can see that the FTSE 250 index of mainly domestically-focused shares has risen eight-fold.

So, the UK is my biggest contrarian recommendation as we move into 2019. There’s lots could still go wrong this year but I can’t help feel that it’s in the price.

UK: cheap versus history

Source: Refinitiv, price index as at 17.12.18.

Past performance is not a reliable indicator of future returns.

Select 50 recommendations: A year or so ago, I interviewed Alex Wright and Nick Train, two excellent fund managers with funds on the Select 50. They have very different approaches, one focused on out-of-favour stocks selling at a cheap price and one looking for high quality businesses that can ride out the ups and downs of the economic cycle but which are often more expensive as a result. Both the Fidelity Special Situations Fund and the Lindsell Train UK Equity Fund could do well in 2019 if valuations recover as the Brexit fog lifts. Having to choose one of these for my annual fund picks, I went for the quality-focused Lindsell Train fund. It is probably better placed if things don’t work out as I hope. But both are good funds and can sit happily alongside each other in a balanced portfolio.

US

Putting your money to work in the US stock market has been the sensible thing to do ever since the financial crisis. Wall Street has been the stand-out performer as the chart shows. Even in 2018, when volatility returned and the US market hit the buffers in the fourth quarter, American shares did better than most other stock markets around the world.

Nothing lasts forever, however. And the big question for investors in 2019 is whether the US can hang onto its crown. If GDP growth continues until July, this will be the longest US economic expansion since before the American civil war. But stock markets look forward and, while the S&P500 has very narrowly avoided a bear market (it fell 19.6% between October and Christmas), it has felt like a kind of reckoning.

The key determinant of whether the bull market resumes in 2019 is the timing of the next recession. Stock markets tend not to fall significantly in the absence of a recession. If a downturn can be avoided then the odds are stacked in favour of further market gains. In roughly 60% of years when recession is more than a year away, the S&P 500 has risen by more than 10%. In the years prior to a recession that gain was achieved only a quarter of the time and in nearly half these years the market fell by more than 10%.

So, if you think that a recession is likely, even as far out as 2020, then 2019 could be the year in which investors start to really price in the downturn. As it stands, earnings are forecast to continue rising over the next 12 months but the probability that this will be offset by lower average valuations is increasing.

The good news is that much of the market froth has already been blown off. Before Christmas, Goldman Sachs looked at three different scenarios for 2019. The most pessimistic of these saw the S&P500 falling below 2,500. At the time the bank made the forecast it seemed far-fetched but the US benchmark hit 2,351 on Christmas Eve. Shares, which are currently priced at 14 times expected earnings have de-rated significantly.

From today’s levels, Goldman Sachs’s base case and bullish case (3,000 and 3,300) would represent an excellent outcome. Even if the S&P500 only ends 2019 where it started 2018, that will be a gain of 7%. When you start from a low base, the odds are stacked in favour of an acceptable return.

Of course, there is plenty to worry about in the US. The Fed continues to tighten policy, the President remains a wild card and who knows how the trade war with China will pan out. But after a savage fourth quarter correction, the risk/reward balance looks much more favourable.

US: still leading the pack

Source: Refinitiv, total returns in local currency, figures rebased to 100.

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in emerging markets can be more volatile than other more developed markets.

Select 50 recommendations: The US funds on the Select 50 have a range of approaches. At one extreme, the JPM US Select Fund has a focus on the technology stocks that did so well but which have disappointed more recently. Its portfolio tends to have higher valuations on average than the more cautious options. These include Angel Agudo’s Fidelity American Special Situations Fund, which struggled to keep up when tech was flying high but has performed much better recently. Agudo has stuck to his guns, avoiding the FAANGs and building a more defensive portfolio that could do relatively well in a slower market. Also cheaper on average than its stable-mate is the JPM US Equity Income Fund. As you might expect, given its income focus, the fund is weighted towards banks, pharmaceuticals and oil & gas.

Europe

Like the UK, Europe benefits from a high average dividend yield. That means an expected 4% price return from European shares next year could be twice as much once the income yield is added in. This means 2019 should be better than 2018, although that would not be difficult after a disappointing year.

Sentiment turned sharply lower last year as investors focused on the twin headwinds of trade tensions and unpredictable politics. Europe is particularly exposed to global trade, with many of the world’s biggest and best exporters. A resolution of the US/China trade spat would provide some much-needed relief in the region.

As for the politics, Italy continues to cast a shadow while the ongoing Brexit uncertainty is unhelpful. Germany is looking to life after Merkel and France’s President Macron has fallen out of favour. It was interesting that the cancellation of the parliamentary vote on Britain’s withdrawal treaty triggered much bigger falls in European shares than in UK ones, which tend to be supported at times of crisis by a fall in the value of sterling.

The good news in Europe is that the de-rating of markets appears to have already taken place, as it has in the UK and Japan. The fall in share prices has been more severe than the expected growth slowdown would imply. Also supportive is the ECB, which will not raise interest rates before the summer at the earliest and quite possibly not then either.

One bright spot in 2019 could be the oil & gas sector, which has a heavy weighting in European markets and could do well if, as forecast, the oil price bounces from its recent lows.

Select 50 recommendation: Given the likelihood that interest rates will remain very low in Europe throughout 2019, keeping a lid on the yields of government bonds such as Bunds, dividend-paying shares in the region are likely to remain in favour. The Invesco European Equity Income Fund, run by Stephanie Butcher, was a disappointing fund pick in 2018 but it could do better this year.

 

Asia and Emerging Markets

After a stellar 2017, last year was very disappointing in the Asia Pacific region, China in particular. Sentiment was hit hard by mounting trade tensions but the real story was the attempt by the Chinese authorities to rein in the country’s huge debts. Cutting off the supply of finance to companies has taken some time to feed through into consumer demand but now the effects are becoming evident in sharply lower sales of big ticket items like cars.

There are two bits of good news for investors looking at the region now. First, the Chinese government is likely to swing back to modest stimulus as it becomes obvious that it may have overplayed its hand in clamping down on credit. Second, the collapse in share prices in 2018 has been so indiscriminate that great opportunities are emerging for stock-pickers in the country. Retail sales are still growing at around 8.5% and GDP growth is above 6%. Against that backdrop, falls of 40% or more in some consumption-related stocks look excessive.

The 2018 emerging market sell-off has taken valuations back to levels that compare with those during the financial crisis. Chinese A shares are an obvious example, but there is good value in other commodity-related businesses, too, such as miners, paper, fertilisers and oil & gas. Many of these shares offer high dividends too.

Although, emerging markets are vulnerable to trade fears and have suffered from a strong dollar, the underlying growth story is firmly intact. The rising purchasing power of emerging market consumers creates great opportunities for stock-pickers who can spot new growth areas.

Emerging markets: still growing

Source: Refinitiv, as at 17.12.18.

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in emerging markets can be more volatile than other more developed markets.

Select 50 recommendations: The past 12 months have delivered highly divergent performances from the Select 50 funds in the Asia and Emerging Markets category. Pick of the list has been the Stewart Investors Asia Pacific Leaders Fund, which invests in mainly large companies which can demonstrate a positive contribution to the sustainable growth of the region. This focus on quality has paid off in a difficult year. Much harder hit, and perhaps due a rebound, is the Fidelity Emerging Markets Fund. Nick Price, its manager, promises a consistent focus on high quality companies which he expects to deliver good returns over the medium to long term as fundamentals reassert themselves.

Japan

Investors in Japan have had a year to forget. Having peaked in January 2018 at around 1,900, the Topix index ended the year at less than 1,500. That still means it has doubled since the election of reforming Prime Minister Shinzo Abe in late 2012 but it was starting from a very low base. Japan remains, in my opinion, one of the most unfairly out-of-favour markets in the world.

So what caused the big sell-off in 2018? The bearish case hinges on a handful of key arguments. The first is the belief that the world is looking down the barrel of a recession. If that were to happen, Japan would suffer more than most because it is highly dependent on global trade. Its stock market is more cyclical than other developed world markets.

The second negative argument is that the country is getting ready to hike its VAT rate in October 2019. Investors remember an earlier tax hike which triggered a big economic slowdown in 2014. A third concern is profit growth, which has been strong but which is bound to suffer if there is a general economic slowdown. Finally, overseas investors - who are a big factor in Tokyo - have been lured away by higher returns in America.

That explains why Japan has underperformed. So why might this be an overreaction? The first reason to be positive is the health of the Japanese consumer. The labour market is extremely tight in Japan and wages are rising as a result. The spectre of deflation no longer hangs over the Japanese economy. Even if the Japanese were not spending, inbound tourists certainly are. The number of Chinese visitors has risen more than four-fold in the past five years.

As for that VAT hike, it really is different this time. For one thing the scale of the hike is lower than five years ago - from 8% to 10% rather than 5% to 8%. In addition, key areas of the economy like food are exempt and there are tax breaks planned for big ticket items like cars and home renovations.

The most important argument in favour of Japanese shares, however, is valuation. Uniquely among major markets, Japanese shares are available at a cheaper multiple of earnings than they were in 2013. Profits have risen faster than share prices for six years. Importantly, shareholders are enjoying a bigger slice of those profits as big positive changes in corporate governance have made Japanese companies more shareholder-friendly. Dividends and share buybacks have grown strongly in the Abe era.

Japanese shares: unloved

Source: Refinitiv, as at 31.12.18.

Past performance is not a reliable indicator of future returns. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment.

Select 50 recommendations: There are three Japanese funds on the Select 50. My favourite, and the one with the best track record, is Baillie Gifford Japanese Fund. Managed by Matthew Brett, who took over the fund recently from the retiring Sarah Whitley, has a focus on Japan’s technological edge, particularly in the area of automation. Another Japanese fund worth considering is Schroder Tokyo Fund, which is managed by the very experienced Japan hand, Andrew Rose.

 

Important information: Please be aware that past performance is not a reliable indicator of what might happen in the future. The value of investments and the income from them can go down as well as up, so you may not get back what you invest. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in small and emerging markets can be more volatile than those in other overseas markets. Reference to specific securities or funds should not be construed as a recommendation to buy or sell these securities or funds and is included for the purposes of illustration only. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Investors should also note that the views expressed may no longer be current and may have already been acted upon by Fidelity. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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