Our playbook for 2019

Last year was one few investors will remember with fondness.

None of the 19 major asset classes performed well. Only two (US and euro government bonds) delivered positive total returns in local currency terms, both a meager 1%. That made the year the worst in a generation in terms of the breadth of the decline. Even 2008 was better – three asset classes ended it up (US and euro government bonds and gold) and by larger magnitudes.

Meanwhile, this year has started with a flurry of bad news.

From weak Chinese data and a sales downgrade by Apple to renewed US-China trade tensions and a continuation of the US federal government shutdown, the reports only reinforce our view that the outlook appears to be volatile and challenging.

But we believe with the right strategies in place the course is navigable.

We identified five of them in our Year Ahead 2019: Turning Points publication that should help investors prosper:

1. Stay invested.

• Global trailing price-earnings ratios fell by 21% last year, leaving them at a post-2013 low. US valuations would need to rise 20% to be more historically consistent with current unemployment and inflation figures. We think markets are overlooking such recent positive developments as the US-China agreement to negotiate on tariffs, the more dovish rate path forecast by the US Federal Reserve, and further steps taken by China to reflate its economy. With a recession unlikely this year, staying invested is the right course of action, in our view. We overweight global equities and emerging market (EM) USD-denominated sovereign bonds while preparing for higher volatility by using portfolio hedges, including long-duration Treasury bonds.

2. Be selective.

• Earnings per share in the US and the Eurozone energy sectors rose at a double-digit rate last year, but the index dropped. The valuations of financial firms are near a 10-year low relative to the wider market, and aren’t reflecting solid economic growth, rising rates, and deregulation. And firms exposed to secular trends like population growth, aging, and urbanization should experience robust growth..

3. Diversify.

• Investors often presume to understand their home market better than foreign ones, which can result in home bias and cause them to miss out on the opportunities that lie abroad. EM equities are valued 25% below their long-term average, and their earnings momentum has picked up. Japanese stocks boast a 15% discount to global equities on a trailing price-earnings basis. Investors could benefit even more by holding unhedged yen positions in the market. Diversifying across market drivers reduces the exposure to individual risks.

4. Go sustainable.

• Companies have come to appreciate that investors can now vote with their wallets, meaning that a lot of their value is tied up in more vulnerable, intangible assets. Accordingly, less-sustainable business practices are likelier to be scrutinized. There’s ample evidence that sustainable investing doesn’t hurt portfolio returns, and the recent sell-off also showed that sustainable stocks (as per the MSCI KLD 400) can perform in line with the S&P 500.

5. Plan ahead.

• With volatile markets becoming the norm, investors could become more prone to making costly mistakes. Laying out a financial plan helps reduce uncertainty as the cycle matures. Our Liquidity. Longevity. Legacy. (3L)* approach helps investors maintain a liquidity buffer to protect spending amid volatility, while ensuring portfolios remain on track to achieve longer-term goals.

We think now is a good time for investors to consider balancing an overweight in global equities with countercyclical positions and – where appropriate – hedges. We also recommend relative value trades (including EM vs. Swiss equities, Canadian vs. Australian stocks, the CAD vs. the AUD, and EM USD-denominated sovereign bonds vs. cash). In addition, investors who can implement options should consider purchasing protective put options on the S&P 500, sized to hedge a fraction of the portfolio's equity exposure. For more on our specific ideas for this year, please refer to our Year Ahead 2019: Turning Points publication.

Bottom line

In 2018, none of the 19 major asset classes performed well. Meanwhile, this year has started with a flurry of bad news including weak Chinese data, a sales downgrade by Apple, and a continued US federal government shutdown. While the investment backdrop looks challenging, we think by staying invested, being selective, diversifying, investing sustainably, and planning ahead, investors can prosper through 2019.

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*Timeframes may vary. Strategies are subject to individual client goals, objectives, and suitability. This approach is not a promise or guarantee that wealth, or any financial results, can or will be achieved.