2018 Q4 Investment Report Commentary and 2019 Outlook
What a Difference a Year Makes
Happy New Year! Even a week into this New Year, we keep celebrating given the better returns so far in 2019. In 2018, investors with average risk generated mid-single digit negative returns.
We are keeping a close eye on the re-emergent volatility. The markets are highlighting the potential of certain growing risks as the business cycle feels late stage. These risks include declining commodity prices, Federal Reserve interest rate policy, ongoing tariff skirmishes, and further potential for market gyrations to influence investor sentiment.
In our view, jobs data, interest rates, global central bank policy, and company fundamentals all remain quite conducive to a healthy global economy. In general, we see less to worry about given the improved valuations resulting from the recent poor markets. 2018 was one of the rockiest years since the global financial crisis and will go down as a year when markets punished all risk taking. Every investable asset class experienced a flat or negative return. This was in stark contrast to the prior year (2017) when virtually every asset class experienced a positive return. See the chart below showing the bifurcation in annual performance.
This return information reminds us why we consistently do the same thing—look for opportunities through valuation, which reflect all aspects of an asset’s price. Otherwise, we risk deviating our allocations too easily due to sentiment or human emotion.
2019 Portfolio Positioning
We prefer stocks to bonds at current valuation levels. We also prefer Emerging Markets and International Equity versus U.S. Equity.
Our graphics display positioning as follows: For asset classes (e.g. Global Equity), Daintree’s relative tactical weight represented by “N” for neutral or up/down arrows for over/underweight. Additionally, the colored tabs along the range between + (overweight green) and – (underweight red) represent underlying sub-asset class (e.g. Emerging Markets) relative weights.
- We are overweight Emerging Markets, which underperformed dramatically in 2018 after a very strong 2017. We expect better returns going forward, given cheaper valuations and perhaps progress on a trade deal.
- Equities (slight underweight) are only modestly expensive relative to other equities. However, earnings growth is slowing, interest rates are rising, and the U.S. economy is later in its business cycle. All of those items make for higher risk.
- We prefer bonds that benefit as interest rates rise, such as Floating Rate Loans. These bonds did well in 2018. Additionally, inflation-protecting bonds (TIPs) continue to offer relative value.
- High Yield remains expensive and therefore higher risk at this time.
- We are underweight Core Long Duration bonds. We prefer shorter duration (or nearer maturity) bonds, given the low yields overall.
- Strategies such as Event Driven/Merger and Macro should benefit as late business cycle investing becomes more challenging.
- Infrastructure MLPs have performed better since their capitulation in March 2018. They recovered, but took a hit again as the price of oil declined in Q4. We see value in this sector particularly since the drop in oil price is mostly supply-driven.
- Real Estate/REITs have underperformed equities since mid-2016 when interest rates bottomed. Despite this, we are not compelled to increase exposure given their long-term excessive run-up earlier this cycle.