It is no secret that 2018 was not as favourable as many investors would have liked. Global financial markets were unstable and unpredictable, with volatility reminiscent of the 2008 financial crisis resurfacing in December. The uncertainty was not constrained to stocks, with bonds, real estate, and other asset classes also experiencing sizeable gyrations.

Given the rising level of concern near year-end and the sharp sell-off in stock markets around the world, it was a relief to see a strong recovery in global financial markets in the final days of 2018 and the continued buoyancy thus far in the early innings of 2019.

This positive start to the year, however, is by no means a sign of an easier road ahead for investors. While it does show that investors are happier that the US Federal Reserve, the world’s largest central bank, is playing from a more dovish playbook, the lingering threats of a US-China trade war, a botched Brexit and slower-than-expected global growth could result in another surprise sell-off in global financial markets.

On balance, however, ongoing volatility could present savvy investors with attractive investment opportunities, but they will need to remain vigilant and particularly risk-cognizant.

2018 Poor Global Market Performance in the Rearview

A major contributor to the poor market performance in 2018 was the ongoing US-China trade dispute and the drag this is already having on the world’s second largest economy, with adverse repercussions for global financial markets.

While there were times that the US and China appeared to be making real progress towards reaching agreement on the trade front, setbacks such as the arrest of a Huawei executive and US president Donald Trump’s call for a ban on Huawei products in the US – and encouraging other countries to do the same – didn’t help investor sentiment.

His unpredictable, off-the-cuff remarks regarding the Federal Reserve’s hawkish stance on interest rates also fuelled investor jitters but the central bank’s more recent dovish stance on rates seems to have placated Trump for now.

Global political uncertainty was exacerbated by Brexit tensions and the fact that the end game is so unpredictable. This and concerns about Italy’s onerous fiscal debt saw European stock markets sell off sharply.

Global Stock Markets Recovering

Notwithstanding these real global challenges, investors were quick to shrug off their pessimism as the year came to a close and have become quite euphoric in the first month and a half of this year. By Friday last week, the broad-based US stock market index, the S&P 500, had gained more than 10% after declining 6.2% last year – setting the tone for other developed stock markets. Some market participants are seeing this rebound as a sign of things to come, betting on a strong comeback in global markets for the rest of the year.

Market analysts are pointing to the fact that markets have already started to recover from the numerous shocks or factors that caused the sell-off last year.

However, I believe the early year rebound could well prove to be a temporary phenomenon, given that many of the headwinds and global dislocations experienced last year remain in place, with no sign of being resolved in the near term.

For example, interest rate adjustments, which have given rise to strong economic growth for the past 10 years, will eventually have to be normalized; the outcome of the Brexit political impasse is still unclear and US-China trade relations remain precarious. Unless these issues are resolved in the first half of the year, there is a good chance this rebound could end up being the calm before the storm. 

Major North American indexes Bounce Back         

After experiencing the worst December for US equities in 50 years, some analysts anticipate a strong recovery in North American stock markets in 2019. They are also expecting continued but moderate growth in US GDP, which should set the tone for the rest of North America given the interdependent nature of the economies. Nonetheless very few are expecting growth anywhere near the 3% growth reported in 2018.

Market confidence, lower unemployment rates, and robust growth in earnings have contributed to the S&P 500’s recovery and the expectation of further upside for the broad-based index this year. In fact, JP Morgan sees the US index possibly reaching 3,000 this year, a 9.3% increase from last week Thursday’s close, as long as a favourable US-China trade deal comes to fruition.

The Toronto Stock Exchange (S&P/TSX) was hard hit by global headwinds last year, falling 15% at one point during the year, knocked by geopolitical instability, financial market uncertainty, trade wars and declining oil prices. Investors became increasingly cautious in the face of analyst expectations that the stock market may be in the late stages of a bull cycle. With some ground regained in the final days of trading, the index eventually ended down 11.6% for 2018.

However, a more optimistic outlook for oil prices and the Canadian dollar has arisen since the start of the year and is in part responsible for the strong performance of the TSX. But this positive momentum is also highly dependent on promising geopolitical and trade events underpinning positive investor and market confidence.

At a sector level, the main drivers of growth for the S&P/TSX composite index in 2019 are expected to be the materials sector, particularly the metals and the energy sectors. The energy sector accounts for roughly 19% of the index, while the materials sector comprises 12%. Such sectors are, however, prone to larger volatility swings when economic conditions are tenuous. This, of course, is a double-edged sword for investors with the patience to seek out quality companies trading at bargain prices in these commodity-related sectors.

Emerging markets Providing Diversification Opportunities

Emerging markets experienced a particularly tough second half of 2018 and are also lagging the developed world financial market rally. JP Morgan analysts are relatively optimistic about the outlook for some of the emerging markets, expecting China, Russia, Chile, Mexico, Brazil, and Indonesia, to gain momentum in the second half of the year and ultimately to show double-digit growth for the year.

South America appears set to benefit from a range of economic tailwinds in the largest economies. Brazil’s looks set to recover from recession in the wake of elections last year, with planned government pension fund reforms this year boosting economic growth.

Mexico, the second largest export market for the US, could experience better economic and financial market performance on the back of favourable trade developments. Meanwhile, measures to boost foreign direct investment in Chile, one of the leading economies in South America, could result in significant growth this year.

While recognizing the increased political and economic risk that may come with emerging markets investments, I would look to these regions as a good source of portfolio diversification and a way to participate in some of the fastest growing countries on the planet at reasonable valuations. Based on an investor’s unique risk profile, and when combined with core investments from more developed markets, this may be a way to broaden the opportunity set for achieving successful investment outcomes.

Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm that manages investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca