Dollar seen losing steam
Bank of America Merrill Lynch is among brokers saying the euro will likely recoup its losses against the dollar in 2019,1 as the Federal Reserve slows down the pace of tightening and the European Central Bank (ECB) gradually removes monetary support. The euro slid 4.8% against the greenback in 2018.
The Eurozone’s central bank, which ended its net asset purchases in December, will likely wait until March 2020 before raising interest rates for the first time in almost eight years, according to Deutsche Bank economists.2 ECB President Mario Draghi’s term expires in October 2019.
Macroeconomic and geopolitical risks
In Italy, the government challenged European Union fiscal rules before reaching a compromise to increase its budget deficit by less than earlier expected. The worsening of financial conditions including wider sovereign bond spreads will more than offset the stimulus provided by fiscal easing, according to Goldman Sachs.3
In the UK, the government and Parliament will decide on how the country leaves the European Union by the end of March. Given a Parliament deadlock and lack of support for Prime Minister Theresa May’s EU withdrawal agreement, the outcome possibilities are wide open. The chances for a range of scenarios have increased: that the UK crashes out of the customs union with no divorce deal, that it postpones or rescinds exiting altogether, or that the electorate is consulted again on the preferred Brexit form.
On the global trade front, the US is working towards a new pact with China by early March. Given the short time frame, the scope of the bilateral trade relationship and President Trump’s hostile rhetoric, there is room for investor disappointment in this area.
Lastly, elections for the European Parliament will be held in May 2019. The vote in the recent past has enabled Eurosceptic and populist parties to gain a stronger foothold in European politics.
Volatility on the rise
Political and economic concerns triggered a pick-up in equity volatility in the last quarter of 2018. The EURO STOXX 50® Volatility (VSTOXX®) jumped to 25.69 on Dec. 27 from as low as 10.9 in January, but it remains well below historical averages and it has recently stayed relatively contained compared to previous market sell-offs. Investors including Aviva Investors4 expect volatility to drift higher in 2019, driving both challenges and opportunities for asset allocators.
“The investment environment is becoming more challenging as the global economic cycle matures,” UBS’s Chief Investment Office wrote in a report.5 “With economic growth, global politics, and central bank stimulus all at turning points, volatility has increased and drawdowns are becoming more commonplace. Investors should expect more of the same in 2019, as markets begin to try and anticipate an end to the cycle.”
Investors have already turned to those parts of the market that have historically had the smallest potential drawdown. The STOXX® Global 1800 Minimum Variance Index lost 3.3% in 2018, nearly a third of the 9.1% retreat for the benchmark STOXX® Global 1800 Index. Meanwhile, the STOXX® Europe 600 Minimum Variance Index declined 7%, less than the 10.8% drop of its benchmark. The STOXX® Europe 600 Minimum Variance Unconstrained Index fell 5.9%.
Waiting for value’s comeback
Morgan Stanley says value investment may come back in vogue in 2019 as rising interest rates make cheaply-rated parts of the market increasingly more attractive.6
The iSTOXX® Europe Value Factor Market Neutral Index was the worst performer in 2018 among seven iSTOXX® Europe Factor Market Neutral Indices, shedding 7.7%. The value index has underperformed the average of the other six factor gauges in all but one year since 2013. The iSTOXX Europe Factor Market Neutral Indices hold a short position in futures on the STOXX Europe 600 to neutralize systematic risk and hence gain exposure purely to the factor premium.
ESG strategies to pay off
Following a difficult year, environmental, social and governance (ESG) strategies may catch up as more investors adopt responsible investment policies and favor businesses with more sustainable operations, according to FactSet. The STOXX® Global ESG Leaders Index dropped 13.7% last year after dividends.
“Alpha associated with socially responsible investing will become a self-reinforcing feedback loop,” said Peter Davaney-Graham, FactSet’s Product Strategist.7 “Companies with poor ESG records will face rising costs of capital and a shrinking investor base. On the flipside, companies with a history of responsible corporate stewardship will be rewarded as investor preference shifts.”
Thematic investing options on the rise
Funds that invest along themes have grown in number and size in recent years, and 2018 saw more options on topics available to investors. Richard Turnill, Global Chief Investment Strategist at BlackRock, expects theme-based strategies to grow in 2019, helped by new-technology megatrends.
“We are seeing client interest in thematic investing soar: tech disruption is one example,” Turnill was quoted as saying in a recent press article.8
- EURO STOXX 50® Volatility (VSTOXX®)
- STOXX® Global 1800 Minimum Variance Index
- STOXX® Global 1800 Index
- STOXX® Europe 600 Minimum Variance Index
- iSTOXX® Europe Value Factor Market Neutral Index
- iSTOXX® Europe Factor Market Neutral Indices
- STOXX® Global ESG Leaders Index
1 Bank of America Merrill Lynch, ‘The Thundering World,’ Nov. 18, 2018.
2 Deutsche Bank Research, ‘The House View,’ Dec. 20, 2018.
3 Goldman Sachs Research, European Economics Analyst, ‘European Outlook – Recovery fatigue,’ Nov. 15, 2018.
4 Aviva Investors, ‘House View 2019 Outlook.’
5 UBS Chief Investment Office GWM, ‘Year Ahead 2019,’ Dec. 13, 2018.
6 Robin Wigglesworth, FT.com., ‘Value stocks show signs of turning a corner in 2019,’ Dec. 5, 2018.
7 FactSet, ‘FactSet Experts Offer Their 2019 Predictions,’ Dec. 31, 2018.
8 Financial Times, ‘Volatility, Brexit and trade: fund CIOs make 2019 predictions,’ Dec. 17, 2018.