Investment Outlook 2019 - A Smithfield Report

INVESTMENT

OUTLOOK

2019

CONTENTS

FOREWORD

FOREWORD

3

BONDS - Goldman Sachs Asset Management

4

UK EQUITIES - Merian Global Investors

7

EUROPE - Principal Global Investors

8

US EQUITIES - Charles Schwab

11

EMERGING MARKETS - Fiera Capital

12

VIETNAM - Dragon Capital

15

RESPONSIBLE INVESTING - Hermes Investment Management

16

PROPERTY - Premier Asset Management

19

TECH - GAM

20

COMMODITIES - Lazard Asset Management

23

GOLD - World Gold Council

24

FUND SELECTION - Quilter Cheviot

27

Andrew Wilde, Senior Director, Smithfield At the beginning of 2018, many asset managers were warning that the biggest risks to global growth were inflationary pressures in the US, central banking policy missteps and geopolitical tensions. These issues were a continual undercurrent during the year, however the past 12 months really only saw two major market flashpoints - the sharp correction in February and the so-called “Red October”.

The prevailing view at the time was that these were corrections, indicative of late cycle behaviour, but not harbingers of a recession...yet. Looking forward to next year, this appears to be very much the consensus of our clients who contributed to this compendium.

The firms whose thoughts on different asset classes make up this book collectively manage trillions of dollars across myriad investment strategies. It would be facile to attempt to capture an overarching view across all of them and it would also fail to acknowledge the nuances of their individual approaches and priorities when managing money.

Nevertheless, some notable common themes emerge.

The bull market is set to extend – although investors point to a slowing of growth and an increase in volatility as late cycle dynamics become more prevalent.

Richard Buxton at Merian Global Investors anticipates we are in line for an economic “soft landing”. Red October, in his view, could be a “pause that refreshes” the markets. This tallies with our own research, canvassing the thoughts of over 100 U.K. investors; although 82% forecast the end of the bull market within two years, 55% were optimistic about the next twelve months.

Brexit, whilst referenced by a number of contributors to this book and clearly important, is not seen as the dominant political risk for investors – even in Europe.

Alex Ross at Premier notes the impact Brexit has had on the volatility of U.K. real estate securities but, equally, identifies a number of “opportunity vehicles” in the sector where valuations in some highly resilient assets have sunk to attractive levels. The political situation in Italy is referenced by Seema Shah at Principal Global Investors as one which could lead to a “market crisis or a European crisis”, with a Corbyn-led Labour Government representing a greater danger domestically than Brexit. Eoin Murray at Hermes highlights the way in which governments and companies address climate change as major factor in investment decision-making in 2019. This view chimes with our investor research which found that 75% of fund managers now see ESG as a key driver in their investment decisions.

We’re extremely grateful to our clients for providing their outlooks for the year ahead. Hopefully you find them both thought-provoking and useful as we head into another interesting and unpredictable year.

3

BONDS Beyond the US, we expect monetary policy normalisation to commence or continue in several other developed markets (DM).

This includes a European Central Bank (ECB) rate hike in late 2019. Euro area inflation remains subdued and growth has moderated but risks of deflation the primary reason for negative policy rates - have subsided. Japan is a notable exception and we expect the Bank of Japan (BoJ) to remain accommodative given absent inflationary pressures.

Andrew Wilson, EMEA CEO, Goldman Sachs Asset Management Recent events demonstrate that central banker words can speak louder than actions. At the start of the quarter US Federal Reserve (Fed) Chairman Powell noted that we are “a long way” from neutral – the policy rate that neither speeds up nor slows down the economy.

Almost two months and no rate hikes later he noted that the policy rate is “just below” a range of estimates for neutral. We acknowledge that recent Fed communique has tilted in a dovish direction. However, we think the large market reaction is overdone, with barely one rate hike priced for 2019.

We expect the Fed’s steady tightening path to continue, though risks to our call for three rate hikes in 2019 are balanced.

With the recent tightening in financial conditions and next year’s expected growth slowdown, we think the case for a pause in the Fed’s tightening campaign has grown stronger. But we also see a risk that wage and price inflation pick up in 2019 given the tightness in the US labour market, leading the Fed to continue hiking every quarter through 2019.

4

Our central bank expectations are informed by our growth and inflation outlooks. We expect convergence to trend growth to be a key theme in 2019. The US expansion is set to become the longest on record if – as we expect - growth continues through spring 2019. However, we think pace of growth will slow due to tighter financial conditions and as the impact of fiscal stimulus fades.

Outside of the US, we think the period of growth moderation is now behind us.

In Europe, growth has reached a more sustainable level and we expect it to stabilize as policy remains supportive.

Across emerging markets (EM), growth in China has slowed as the economy rebalances but also due to trade tensions.

We think markets have gone too far in pricing risks of a full-blown trade war and we see scope for a stream of policy support measures, particularly out of China, to support Chinese and broader EM growth.

Expansionary growth alongside tight labour markets will continue to sponsor the steady rise in core inflation, while headline inflation looks set to moderate on lower oil prices.

From an investment standpoint, we believe 2019 offers some important advantages relative to 2018. Valuations look more attractive after a challenging year for assets. And unlike today’s starting point,

“WITH MACRO EXPECTATIONS ADJUSTED SHARPLY LOWER, WE THINK THE BAR FOR POSITIVE SURPRISES IS LOW.”

conditions heading into 2018 were hard to beat, resulting in a situation where most surprises were negative. That is not the case going into 2019. With macro expectations adjusted sharply lower, we think the bar for positive surprises is low. 2019 will likely see increased focus on the end of the cycle with the temptation to take down risk. In our view, the fundamental backdrop suggests it is too early to de-risk. Economic growth is slowing but still growing and the rise in core inflation is steady not speedy, while central bank tightening is gradual not rapid. Additionally, corporate profit margins are still expanding.

Taken together, these factors – attractive valuations, a low bar for positive surprises and still-healthy fundamentals – lead us to remain pro-risk with a preference for equities over credit and credit over rates. The 2019 risk-reward for equities has improved relative to 2018 after the de-rating in valuation

multiples and we expect the continued expansion to underpin earnings and in turn equity performance. We have also turned constructive on US corporate credit as recent weakness provides an attractive opening to add exposure in light of strong fundamentals. Among macro markets, we favour underweight rate and overweight currency exposure to markets where central banks are nearing policy normalisation (such as Sweden and Norway) relative to economies where central banks are wary of household rate sensitivity (such as Canada and Australia). Regionally, we continue to prefer EM over DM. EM asset devaluations – particularly in currencies and equities – have surpassed what we believe is implied by underlying fundamentals. In 2019, we think EM asset performance may be unleashed by improving growth and upside policy surprises.

5

UK EQUITIES management industry seems to shy away from because they are concerned about Brexit. British companies are in pretty good shape. They are trading on around 14 times earnings, near the 40-year average, so not expensive. I expect the UK economy is going to gently accelerate into 2019. There is a very strong labour market, and the chancellor is prepared to increase public spending.

Richard Buxton, Head of UK equities, Merian Global Investors The wild ride in asset prices at the start of the fourth quarter may have left some investors fearing the worst and wondering about the direction of financial markets.

The impact of central bank unwinding, slowdowns in China and emerging markets, along with trade war ructions signalled, for some commentators, the end of the long bull run in equities.

“WE SEE OPPORTUNITIES IN THE UK THAT THE INTERNATIONAL FUND MANAGEMENT INDUSTRY SEEMS TO SHY AWAY FROM BECAUSE THEY ARE CONCERNED ABOUT BREXIT”

I don’t agree. A little fear isn’t a bad thing.

October brought a healthy shakeout in equity markets and a breaking of some momentum trades. It may also have helped us on our way to a better place.

This should be seen as “the pause that refreshes” the US economy and steers it clear of a recession in 2020 that is forecast by many economists.

Closer to home, we see opportunities in the UK that the international fund

6

We’re not the only ones who see good value. Overseas corporations continue to buy UK companies, or parts of them, as we saw with Coca-Cola buying Whitbread’s coffee business.

There’s potential for a change in leadership in the market as interest rates gradually move upwards, led by the US but I expect the Bank of England to do more next year also. Rising interest rates and higher volatility are good for banks, so they may become more in favour, while growth stocks, tobacco and consumer staples, may begin to come under pressure. We also see interesting selfhelp and turnaround situations, when new management comes in to improve companies, like at Tesco.

There will be patches of turbulence here and in the US but we’re preparing for a soft landing. While we’re constantly reviewing our holdings, we’re absolutely comfortable that our portfolio of wellmanaged companies, trading with attractive valuations and offering consistent returns, is the right one.

7

EUROPE potentially forced by market discipline if sovereign yields shoot up so much that the Italian government has no choice but to reign themselves back in. The other possibility is an internal recalculation where Italians come to understand that the budget numbers don’t add up and that a less antiEurope attitude is the way forward. While this story searches for its ending, expect continued volatility in European markets.

Seema Shah, Senior Global Investment Strategist, Principal Global Investors 2019 will likely mark the year that Brexit officially materializes. Resolution of this political drama should be a short-term positive for sterling, but a long-term negative as the UK economy likely struggles with a loss of confidence and activity. My primary concern, however, will be that a leadership contest may pave the way to a general election – and a Jeremy Corbyn led Labour government.

Nationalization, an increase in corporate taxes, and a higher minimum wage could spell trouble for financial names in the UK. Moving to broader Europe, the continuation of the Italian saga will play a big role in Europe’s outlook. Italy is attempting a balancing act to appease both Italians and the European powers that be, but this raises the risk of either a market crisis or a European crisis.

How does the Italian drama play out?

One possibility is that Italy’s deputy prime minister, Matteo Salvini, steps down,

8

Investors could expect this low-grade tension with Italy to extend perhaps into t he second quarter of 2019, when eventually the tensions will likely come to a head.

The next area I’ll be watching in 2019 is who the European Central Bank (ECB) picks to take over for its current president Mario Draghi. I’m expecting some economic headwinds from a more hawkish and less market friendly successor. If that comes to pass, at some point in 2019, markets will start to reprice their interest rate expectations for 2020, and will begin contemplating whether the ECB starts reducing their balance sheet ahead of expectations.

Another issue to pay attention to is how the ECB handles their long-term refinancing operation (LTRO) scheme that’s been in place since 2011. New banking regulations from Basel stipulate that these LTRO funds cannot be allocated to their capital requirements. If the ECB decides to issue a new LTRO, it could deal with the new Basel regulations and address some liquidity concerns. If it comes to pass, investors could expect some relief of banking stress, particularly within Italy.

“WHILE THE ITALIAN STORY SEARCHES FOR ITS ENDING, EXPECT CONTINUED VOLATILITY IN EUROPEAN MARKETS.”

9

US EQUITIES economic growth take their toll. But the story is no longer just about tech stocks surrendering their leadership as market drivers. Now, an increasing number of highly leveraged companies are coming under pressure from rising interest rates, which is making debt-financing costlier.

Similarly, the tax cuts that the current administration signed into law almost a year ago have had little or no effect on most US companies’ hiring and investment plans. In 2019, the market will be watching how much of those tax-driven earnings will be capitalised or whether the policy was no more than a temporary shot in the arm.

Kully Samra, Vice President, Charles Schwab, U.K. Limited

“THERE IS CONCERN THAT FURTHER QUANTITATIVE TIGHTENING COULD PUSH FINANCIAL CONDITIONS TO BREAKING POINT, CAUSING FISCAL POLICY TO CHANGE FROM A TAILWIND TO A HEADWIND”

10

As we reach the latter stages of the economic cycle, investors are increasingly asking how long the bull run in US equities can last. Rising wages, strong earnings, high consumer confidence, low unemployment, and a growing economy have buoyed US stocks. However, volatility is now returning, thanks to interest rates hikes, the Federal Reserve reducing the size of its balance sheet, as well as the White House’s as yet unresolved trade tensions with China.

The end of 2018 has seen the U.S. stock market reach market correction territory, in part driven by concerns over the prospects for some of the biggest technology-related stocks— as the outlook for earnings, the potential for regulatory changes and slowing global

The Treasury yield curve has flattened considerably since the Fed began regularly raising rates. An inversion doesn’t automatically signal a recession, but we do see increasing risk heading into 2019 and expect more spikes in volatility and even some fierce pullbacks or corrections. That said, the end of the year has historically been a good time for stocks, particularly in midterm election years, so seasonal factors of this kind could provide some support in the near term.

The Fed has admittedly taken a more dovish stance and admitted the path of future rate hikes will be determined by the data, however there is still a nervousness that too many hikes too fast could be a monetary mistake. There is concern that further quantitative tightening could push financial conditions to breaking point, causing fiscal policy to change from a tailwind to a headwind in 2019.

11

EMERGING MARKETS Looking ahead to 2019, we think emerging market currencies are likely to recover, in the absence of a breakdown of the world trading system. Even though emerging market debt has risen, it has stopped rising and remains below the levels for Developed Markets.

Julian Mayo, Director, Fiera Capital For emerging markets, a key challenge in 2019 will be how they fare in any potential trade war. At the moment, this is still very much a major unknown, albeit a known unknown. The US already has the highest import tariffs in the G7 but the possibility is that tariffs are implemented on all US$500 billion plus of imports from China. This could lead to lower growth in both developed and emerging markets, even if it may be some time before it is felt given the complexities and interconnected nature of global supply chains, and the multiplier effects on domestic demand.

In our view, President Trump’s primary objective is re-election in November 2020.

Therefore, he will not aggressively pursue a tariff policy which would greatly reduce spending power in his core support. This would suggest that a deal with China will be made. In addition, encouragingly many emerging markets have the fiscal firepower to counteract these negative developments. Combined with the improved competitiveness, as a result of currency weakness during 2018, this will reduce the impact of the tariffs.

12

Furthermore, emerging market current accounts are less vulnerable than in 2013 and we should start to see improvements through 2019. Consensus forecasts are for GDP growth in EM of 4.5-5% for both this year and next, even accounting for slowdowns in the likes of Turkey and South Africa. As developed economies should slow next year, this means that the growth gap between the emerging and developed worlds should expand. The distribution of this growth will change over time. For example, oil consumers – the vast majority of emerging markets - are benefitting from the sharp fall in the oil price towards the end of 2018.

The US dollar is unlikely to strengthen much further in 2019. The fiscal stimulation is a 2018 story while we are approaching the end of the monetary tightening cycle. We think developing markets should ultimately prove resilient to a tighter Fed in the context of undemanding valuations, thanks to the broad improvement in global growth, robust earnings growth and favourable dollar conditions.

As bottom-up investors, developments in corporate profits are critical to us. Some overly optimistic analysts have been revising down their earnings growth forecasts, partly due to currency fluctuations. However, expectations for next year are seemingly settling on low teens growth, which are still healthy numbers, particularly if questions over sovereign governance in 2019 bring developed market risk into sharper focus.

“LOOKING AHEAD TO 2019, WE THINK EMERGING MARKET CURRENCIES ARE LIKELY TO RECOVER, IN THE ABSENCE OF A BREAKDOWN OF THE WORLD TRADING SYSTEM.”

13

VIETNAM trade surpluses. The low level of foreign debt has resulted in a debt service ratio of 4.2%, the lowest in emerging markets. In short, Vietnam is not facing anything even remotely like what Turkey, Argentina and Indonesia recently experienced.

Dominic Scriven, Executive Chairman, Dragon Capital Vietnam has established itself as one of the most dynamic emerging market economies.

With 1H2018 GDP rising by 7.1% and full-year growth set to reach 6.9%, it has achieved an ideal balance between growth and stability. Headline inflation is around 3.5%, while interest rates and the currency are stable. However, external risks are materialising, and this has stalled the market’s run, leaving it down so far in 2018. Should investors be cautious? Or is there enough support to continue Vietnam’s run as the “best in class” investment destination?

The familiar story of imploding emerging markets on the back of an ongoing trade war, currency flight and an inflationary bubble, is not Vietnam’s lot. Its rapidly expanding middle-income class is the main internal driver for the economy, with domestic consumption making up around 70% of GDP.

“WALKING THE MIDDLE GROUND BETWEEN CHINA AND THE US IS A CHALLENGE THAT VIETNAM WILL MANAGE”

14

Foreign direct investment at 6-8% of GDP, or around $15bn, is robust – thanks to a competitive labour market where the well-educated average worker costs a sixth of that in China. Supported by the Government’s rapid development of infrastructure, exports are expected to grow by 14.5% for 2018, resulting in modest

So what else is going on to support the market, when external factors are so unpredictable? Firstly, the modernisation and expansion of the stock market itself.

Derivatives trading has been introduced in the form of the VN30 index futures, and covered warrants and bond futures are on the way.

Foreign ownership limits are also on target to be resolved through a system of non-voting depository receipts (NVDRs), like Thailand.

Along with the macro-economic fundamentals helping to drive earnings, the market has been expanding, and this is set to continue in 2019. The IPO process, divestments from already-listed state-owned enterprises, and private placings have seen market capitalisation treble in the last five years to $180bn.

This broadening of the market is fueling the move to Emerging Market (EM) status and MSCI inclusion, which is the long-anticipated catalyst for more active coverage from global money managers. It is estimated that achieving EM status would result in the buying of an additional $10bn of Vietnamese equities.

Trade wars may indeed escalate nervousness over the sustainability of an export economy like Vietnam’s. But walking the middle ground between China and the US is a challenge that Vietnam will manage, as Vietnam’s trade surplus is based on exports that are not in the sites of the trade negotiators. Looking forward, with 2019 earnings expected to grow by 12% on a price-earnings ratio of 12x, Vietnam has an underlying value that separates it from the mayhem of other emerging markets.

15

RESPONSIBLE INVESTING fact be too late for either. The wonders of science are such that our understanding of the issues and effects of climate change develop every year – the bad news is that the outcome, not a good one, is also better understood.

Eoin Murray, Head of Investment, Hermes Investment Management There will be three central themes for 2019: (i) an increased focus on all things ESG, particularly climate change; (ii) further boosts to the cause of diversity and inclusion; &, (iii) an end to the bull markets in equities and bonds, ten years in to the former and more than thirty years in to the latter.

The IPCC’s timely reminder in October that 2°C warming of our planet may be too much served to re-energise the climate change movement. Many have suspected for a while that the more ambitious 1.5°C target may be the right one, but it may in

16

2018 was the year of the woman: consider the #MeToo movement, the mass protests against the appointment of Judge Kavanaugh to the US Supreme Court, or the critical role played by women in politics (as both politicians and voters in the US midterms, representation in the Mexican congress, or the equal gender split in the French cabinet). 2019, then, is the year for the investment industry to truly pick up the challenge – I firmly believe that social diversity is the last free lunch of diversification – we’ve enjoyed spreading our capital across asset classes, sectors and geographies, and now we must take advantage of diversity, if for no other than good economic reasons. It simply makes commercial (and investment) sense.

Our investment focus will change in other ways too – absolute will replace relative return, alpha will trump beta, and a longterm investment focus will come to the fore. The next several years will present new challenges, or at least ones not seen for the last ten years. But a longterm horizon will also reveal opportunities perhaps less well-appreciated in the old short-term world.

“I FIRMLY BELIEVE THAT SOCIAL DIVERSITY IS THE LAST FREE LUNCH OF DIVERSIFICATION”

17

PROPERTY However, these potential write-downs are now widely expected by the equity market and are reflected in share prices trading at material discounts to net asset values.

For European retail property, we see less operational risk, as retailers are not seeing the same cost pressures and rents are typically more affordable.

Alex Ross, Senior Investment Manager Premier Asset Management

“LONDON AND PRIME RETAIL ARE MOST VULNERABLE TO A DISRUPTIVE BREXIT SCENARIO, HOWEVER, WE SEE A NUMBER OF THE LONDON FOCUSED QUOTED PROPERTY COMPANIES AS EFFECTIVELY ‘OPPORTUNITY VEHICLES”

18

We expect UK real estate securities to remain volatile amidst the ongoing uncertainty of Brexit, with short term price movements reflected by the path of Brexit negotiations/outcome. London and prime retail are most vulnerable to a disruptive Brexit scenario. However, we see a number of the London focused quoted property companies as effectively ‘opportunity vehicles’, as they have positioned themselves for this potential risk with strong balance sheets that will allow them to capitalise on buying opportunities.

The seismic shift in the UK retail property market is set to continue as the impact of online shopping, combined with retailer cost pressures, sees most retailers further shrinking their physical estates. We are expecting some material write-downs in retail property valuations in most retail assets in the UK, but these will be more limited where there is tenant demand to maintain space in this retail space retrenchment, most notably in the more affordable convenience retail segment.

Whilst the retail property market faces ongoing technological challenges, the logistics property market is a key beneficiary of the shift to online retailing.

Both online and physical retailers are increasingly seeking large regional warehouses and urban warehouses to meet the consumers’ demand for rapid delivery, but with a shortage of available warehouse space, pricing power is very much with the landlords and healthy rental growth is expected.

We are expecting further rental growth for Grade A and renovated offices in growth cities, most notably Stockholm, Berlin, Madrid, central Paris and Dublin.

Occupiers increasingly want vibrant and well-located offices to help attract key creative talent and the winners here will be those landlords able to create such space in markets where the supply outlook remains low.

Our largest sector exposure is German residential, where the healthy demand, low supply and good affordability ratios are set to drive further rental and capital growth.

Supply remains structurally limited, with most existing stock still typically valued materially below their rising construction cost. House prices in Germany have finally started to grow materially in the last few years, but there is significant room for catch up towards other global residential market levels and only when this is reached is the much-needed increase in supply likely to occur.

19

TECH names such as Salesforce and Amazon fell sharply but were ultimately unharmed. The mistake the market made was assuming that economic downturn affects all companies equally and we believe this will also be the case in the current cycle.

Mark Hawtin, Investment Director, Gam Investments Technology stocks have been fiercely punished through recent equity market weakness. Trade tensions between China and the US, and ongoing uncertainty in Europe from Italy and Brexit, have served to re-focus market attention on the trajectory of economic growth globally. The result has been a sharp and indiscriminate sell-off across global markets, and tech has suffered the consequences.

Those quick to forecast doom and gloom for the coming year have focused on traditionally fertile areas for selling in the technology space: China and the internet because of the trade wars; storage and memory because of the feared economic slowdown; and large cap technology because they are over-owned. From a fundamental point of view, this stance could not be more wrong. We believe the evolution of disruptive technology has never been as strong or growing as quickly as it is today.

If we look back at the performance of tech stocks during the last major market downturn of 2007-2008, shares in leading

20

Looking ahead to 2019, as long as the disruption in technology continues, there will be strong companies with the ability to carve out substantial markets for themselves. Therefore, we believe the current sell-offs in technology shares should be viewed as attractive opportunities to have another bite at the proverbial Apple.

We believe the next big driver of technology is going to be blockchain. As the principal technology underpinning cryptocurrencies, blockchain has been caught up in some of the negative news flow. Yet it is starting to be seen in its own right as a valuable technology for automating the process of trust, allowing users to disintermediate in areas which currently require a trusted party.

Ultimately, it should cover multiple forms of transactions, from buying and selling concert tickets online, to transacting real estate deals, which could further eradicate the need for estate agents or lawyers to a certain degree. Even certain levels of accountancy within business transactions could be eliminated.

“THE EVOLUTION OF DISRUPTIVE TECHNOLOGY HAS NEVER BEEN AS STRONG OR GROWING AS QUICKLY AS IT IS TODAY�

That said, it is not just a matter of identifying the biggest themes and opportunities. These are important, but it is just as crucial to consider the intrinsic value of a company. We believe there is still enormous opportunity surrounding the technology sector, but with that resides the potential for exuberance and investors need to be mindful of this.

21

COMMODITIES

Terence Brennan, Portfolio Manager, Lazard Commodities Fund

“WITH INTEREST RATES RISING AND THE PROSPECT OF INFLATION THE MOST CREDIBLE IN YEARS, THE ASSET CLASS IS RESUMING ITS TRADITIONAL PORTFOLIO-DIVERSIFYING ROLE.”

22

Quantitative easing has been an anomaly for commodities. The diversification benefit of the asset class, which broke down after the global financial crisis following the flood of money from central banks, caused investors to look elsewhere for returns. Commodities are now, however, starting to come back into favour. As we move into the next period – be it quantitative tightening or tweaking perhaps – with interest rates rising and the prospect of inflation the most credible in years, the asset class is resuming its traditional portfoliodiversifying role.

Looking ahead, we remain positive on the prospect of increased US and global infrastructure spending. Despite expectations for increased conflicts and gridlock in US Congress following the mid-term elections, with roads and railways in desperate need of repair, this is one area both the Democrats and Republicans agree on spending. In China, we’ve witnessed in recent months the fast-tracking of infrastructure projects to boost slowing growth and we expect this additional stimulus to continue into 2019. Meeting this critical challenge promises to vastly increase demand for industrial commodities like copper, cement, and steel.

Underinvestment and a drawdown in supply has been a common trend in the base metals, mining and oil due to continued low prices. Low prices and price uncertainty is problematic for producers. Producers tend to produce less when prices are low. Inventory, then tends not to build, as low prices do nothing to deter demand.

With commodity producers essentially not replacing supply, and demand remaining relatively stable, a new cycle is then established. Under-supply, and the price inflation it implies, should bid up the value of a commodity investment for as long as it takes capital expenditure in the commodity complex to recover. Meanwhile, the global debt burden has enhanced the commodity diversification premium and adds to commodities’ appeal as the zero-duration investment.

For longer term trends and components of tomorrow’s transport—such as the rare metals used in batteries for electric vehicles - battery-grade nickel is of increasing interest as a substitute to cobalt. Carmakers are trying to reduce the amount of cobalt they use in every electric car battery as the value of the commodity has soared and mining conditions and health and safety standards have been called into question with the rise of ‘conflict cobalt’.

As electrical vehicles continue gaining market share, the transfer from combustion engines to electronic vehicles may cause oil producers to remain cautious about future spending looking ahead to the next ten years. We are still overweight oil at the moment.

In terms of tailwinds for the asset class moving into 2019, fundamentals do not speak to a sustained strengthening of the dollar. We’ve already started to see the dollar weaken and over the next few quarters, we expect the US dollar to continue to weaken, or at the very least, take a pause.

23

GOLD as seen in 2018. All of these sources of demand are not only relevant to gold’s performance next year, but also underpin its long-term performance.

John Reade, Chief Market Strategist, World Gold Council The gold price trended down from April, hitting a low of $1,160 per ounce in August as the dollar strengthened, the Fed continued to hike interest rates while other central banks kept policy accommodative, the US economy was lifted by tax cuts and bullish investor sentiment pushed US stocks higher – until October. But as risk in emerging economies started to spill over to developed markets, global stocks sold off led by US tech companies, resulting in short-covering in gold and its price rising comfortably above US$1,200/oz.

But what is in store for gold next year? We expect that the key factors that drove gold in the second half of 2018 will continue to hold sway over the market in 2019.

Physical buyers, whether they are in China or India, which together make up half of consumer demand for gold, should be solid, bolstered by good growth in these two important economies. Central banks, whose collective buying has been one of the standout positive surprises this year, are widely expected to continue to buy gold next year and it’s possible that additional central banks will join, 24

The most important component for near-term price performance, however, will be linked to the activity of investors – whether driven by strategic or tactical reasons. These investment flows, stemming primarily from the US and European markets and with China becoming increasingly important, will likely be driven by macro-economic factors such as perceptions of risk, and the direction of interest rates, as well as by momentum and positioning in the gold market – especially in the US. If US stocks recover from their current bout of weakness and if the economy continues to out-perform the other major economies, the dollar may remain strong and gold may struggle to push significantly higher. But if US growth slows, as the sugar rush from the tax-cuts passes or if trade wars or tighter monetary policy create further drag, then investors may continue to seek gold. Furthermore, if the economic slowdown is rapid or if risk assets fall sharply, investment flows into gold could match those seen during the 2008-2009 financial crisis.

With gold currently trading at less than two-thirds of its all-time high, in contrast to the lofty valuations of US stock markets, we believe now is a very good time to consider the role of gold in a portfolio.

As a high quality, liquid asset, with the potential to deliver strong returns, and as an effective diversifier that works particularly well when other assets fall sharply, gold has historically proven to enhance the long-term performance of investment portfolios.

“IF THE ECONOMIC SLOWDOWN IS RAPID OR IF RISK ASSETS FALL SHARPLY, INVESTMENT FLOWS INTO GOLD COULD MATCH THOSE SEEN DURING THE 2008-2009 FINANCIAL CRISIS.”

25

FUND SELECTION Disintermediation from Amazon, where the online giant effectively cuts out ‘middlemen businesses’, has been top of mind for the team. It’s encouraging that the fund take changes in the economy seriously – and sees them both as a potential threat for their existing positions, but also as opportunities where the threat might be overrated.

Nick Wood, Head of Fund Research, Quilter Cheviot

My one fund for 2019: Vulcan Value Equity

“IT’S ENCOURAGING THAT THE FUND TAKES CHANGES IN THE ECONOMY SERIOUSLY – AND SEES THEM BOTH AS A POTENTIAL THREAT FOR THEIR EXISTING POSITIONS, BUT ALSO AS OPPORTUNITIES WHERE THE THREAT MIGHT BE OVERRATED.”

26

Of the US based funds on our buy list, Vulcan Value Equity stands out as one that, from a relative standpoint, we think is likely to perform well going forward.

The Alabama-based manager seeks a combination of attractive valuation as well as inherent underlying company growth. This leads to a higher quality value portfolio, holding more traditional value names alongside higher growth names that have significantly de-rated.

Whilst Vulcan is perhaps a less well known manager, it is well established, having been set up in 2007 by CT Fitzpatrick.

He has a large team of highly experienced analysts working with him, investing in US value companies. The fund tends to be quite concentrated, with the team happy to hold large weightings in companies.

Vulcan Value Equity has enjoyed great success since launch, and indeed at their 10 year anniversary in 2017, they were the lead US value manager over that decade.

We think the fund offers a differentiated approach and one which we expect to do well in 2019 for those looking to invest in the US. The fund has historically done well in falling markets, and whilst we are not predicting a major correction in the US, the combination of protecting assets in a falling market and being willing to take advantage of share price declines should make this a good environment for the fund. Lastly, the manager has tracked the level of discount that the fund is trading at, based on its view of the upside in each of the underlying holdings. That discount is now as wide as it has been since 2011.

Today the fund is biased primarily towards financial and technology stocks. Within technology, the fund holds a large position in Oracle, where they are attracted to the value of the cloud technology. The stock is notable as one which Warren Buffett recently bought into.

27

CONTACT Andrew Wilde Senior Director awilde@smithfieldgroup.com +44 (0)20 3047 2544