It may be time to say goodbye to 2018, but sadly that does not also mean that it’s time to say goodbye to worries plaguing the markets. Thus far, this year has been marked by two stock market corrections, the return of market volatility, interest rate hikes, escalating trade wars, a heated midterm election and surging worries about the ongoing strength of US corporate earnings.
We surveyed hundreds of clients to find out how these contentious events are influencing their outlook and asset allocation plans for 2019. Below are the results of our annual year-end survey, which indicate investors are expecting certain changes in market conditions.
Investors’ top three concerns for 2019
Investors told us their top concerns for the New Year are:
- A global economic slowdown
- Geopolitical and international trade tensions
- The end of the US equity bull market
Nearly 85% of respondents—whose concerns are listed above and captured in the chart below—selected a global economic slowdown as one of their top five concerns for 2019. This is up from 63% when we conducted our Mid-Year Investor Survey. This response is not much of a surprise given how sanguine global macro data and reductions in earnings growth estimates have swayed market activity throughout 2018. The below chart depicts investors’ responses in aggregate.
Investors’ portfolio construction plans
Investors’ top three worries, captured above, appear to play into survey respondents’ top 3 portfolio construction goals for 2019, which are listed below:
- Construct balanced portfolios
- Generate total return
- Keep investment costs low
In the New Year, it’s likely that investors will be facing a downhill climb as global growth slows and equity market momentum wanes. Constructing balanced portfolios will require balancing equity risk with a robust fixed income exposure to generate the total returns investors are seeking in today’s aging, late cycle economy. Keeping investment costs low will be vital to reaching total return objectives in 2019 if return expectations are low.
Source: SPDR Americas Research, as of 11/16/2018.
Asset allocation plans: Heading overseas
The below chart tracks investors’ asset allocation plans, and it shows the highest portion of investors who plan to increase a regional allocation plan to do so in emerging markets (EM)—despite expressing worry that 2019 will be marked by slowing global growth and geopolitical tensions. Our survey found 38% of investors intend to increase their EM equity exposure in the first half of 2019 while only 12% will be actively reducing exposure. This is a continued trend from mid-2018 when 44% of investors said they planned to increase EM exposure.
Developed international exposures are also likely to see a similar uptick in asset allocation, with 31% of respondents planning to increase broad exposure. However, European equities will see a slightly lower increase in allocation given that geopolitical risk is potentially higher in the region due to the looming Brexit deadline and Parliamentary elections in May. The focus from investors outside the US in broad based developed and emerging markets primarily comes down to value, as valuations for non-US equities have improved with the MSCI ACWI-ex US trailing the S&P 500 by 13% over the past year, after falling 18% from peak to trough in 2018 and nearly entering a bear market.1
In the fixed income sleeve of a portfolio, investors said they’ll continue to seek the benefits of floating rate notes and senior loans, with 27% saying they intend to increase their allocation to these exposures—even though mitigating rising interest rates landed at the bottom of investors’ stated concerns for 2019. The interest in floating rate structures is likely due to the noticeable yield (3.18%) obtained for very little duration extended (0.13 years) combined with the rate forecast ahead from the Federal Reserve where short-term rates may be hiked 3 to 4 more times by the time we close the books on 2019.2 Some of this allocation may be attained by selling high yield as 34% of survey respondents indicated they plan to reduce exposure to the sector in the New Year. Note, we conducted this survey while high yield was selling off, so some of this may be from recency bias. Overall, however, high yield credit spreads still remain tight versus history so valuations continue to be a concern, particularly in these later stages of the credit cycle.3
While investors may be eyeing opportunities in EM stocks, they are cautious as it relates to EM debt—39% of investors stated that they have no EM debt exposure and a further 17% said they plan to reduce their allocation. Given US dollar strength, and the recency bias of currency crises in Argentina and Turkey, this could be an indication that trade tensions could weigh more heavily on debt markets than equities.
Sectors: Defensiveness on the rise
In the sector space, investors are steering clear of lower growth bond proxies like real estate and utilities, as well as from cyclically oriented materials. Instead, they are favoring health care—a sector that is seen as more growth-oriented and more stable. Fifty-six percent of respondents were overweight the health care sector, and 5% are neutral. This is up from our mid-year survey, which found a 47% overweight to health care. Investors are also showing an interest in the financial sector, which could be driven by rising interest rates.
However, investors’ sector allocations show there is some disenchantment with the once-popular technology sector. Although tech remained the third-most over-weighted sector, at 40%, that is a sharp fall from our mid-year survey, when 54% of respondents were overweight the sector. Even more telling, just 8% of respondents were underweight the tech sector at the mid-year, while a hefty 46% are now underweight the sector.
This sharp allocation drop may be attributed, in part, to the fact that our most recent survey was conducted in mid-November, when shares of the world’s largest tech stocks took a pounding due to worries over slowing growth and profit forecasts. It could also signal that investors are playing defense heading into the New Year, curtailing exposure to risky tech stocks in favor of more defensive ones, like health care.
Source: SPDR Americas Research, as of 11/16/2018.
Factor views: Value still an overweight but waning as minimum volatility rises
Defensive positioning is also creeping into factor exposures as the US stock market hits a volatile patch and tech stocks take a beating. The chart below shows investors are reducing their exposure to value, lessening their exposure to momentum over time, and piling into minimum volatility.
Investors are also gravitating toward quality. In today’s late-cycle environment, firms with reliable cash flows and stable balance sheets are more likely to be rewarded in the marketplace, and these are two traits of firms commonly found in the quality factor exposure.
Investors go on the defense heading into 2019
Based on responses to our survey, it’s clear that investors are positioning for a market environment that will require a more defensive posture in the New Year. Investing with this defensive tilt may allow investors to weather upcoming risks—like Brexit, European Union Parliament elections, interest rates hikes and a potential slowdown in earnings—without needing to forgo income generation—a key to meeting total return targets.
About the Survey
A total of 461 investment professionals completed State Street Global Advisors’ online year-end survey, the goal of which was to determine the investment concerns and client portfolio considerations that were top of mind for investment professionals. The survey was fielded in November 2018. Respondents represented a variety of investment professional segments holding a wide range of assets under management.
1Bloomberg Finance L.P., as of 11/26/2018.
2Bloomberg Finance L.P., as of 11/26/2018.
3Bloomberg Finance L.P., as of 11/26/2018.
The volatility factor is a common driver of equity returns that is based on the observation that lower volatility stocks tend to generate a higher risk-adjusted return than high volatility stocks.
The quality factor is a common driver of equity returns that is based on the observation that healthy companies tend to outperform less healthy companies.
The size factor is a common driver of equity returns that is based on the observation that stocks of small companies tend to earn greater returns than stocks of larger companies.
The value factor is a common driver of equity returns that is based on the observation that inexpensive stocks tend to outperform more expensive stocks.