Our outlook for 2019 is set against a backdrop of increasingly difficult global economic conditions and political uncertainty. This uncertainty has brought about significant, and broad-based, volatility and price weakness in the equity market. We expect active management, especially the concentrated, best ideas approach employed by the Alliance Trust portfolio, can take advantage of this volatility, by identifying companies that have been sold off without regard for their true intrinsic value. Combining the 20 best such companies from each of our eight high-conviction managers, we believe we have created a diversified portfolio that will be able to provide our investors with a smoother, less volatile but hopefully more rewarding investment experience.
Coming into 2019, both economic policy and political uncertainty are elevated globally, making it increasingly difficult to predict economic outcomes, with an increasing range of potentially negative ones. We expect growth in the major economies to steadily slow. While there are many drivers for this, rising interest rates and the unwinding of quantitative easing by central banks will make developed equity markets overall more challenging, through reducing liquidity and increasing volatility. Although we believe that global growth will slow, current markets are still projecting expectations for relatively strong growth. As a result, the portfolio is currently managed at the lower end of its gearing range.
Market expectations for US earnings growth next year are optimistic – leaving scope for earnings disappointment in 2019. Therefore, under current valuations, we view more risks to the downside in US equities. On the other hand, emerging market equities have been declining over 2018 and are cheap on a relative basis, with greater potential for growth. The Alliance Trust portfolio is managed in such a way as to ensure that stock selection drives returns; however, currently the bottom-up portfolios built by the managers have a slight underweight position to the US and slight overweight position to emerging markets as a result.
Active management faced strong headwinds in 2018. This difficult environment can be attributed to late-cycle behaviour where investors, in a low-returning environment created by monetary and fiscal stimuli, were attracted to a narrow group of stocks promising future growth, but whose prices incorporated such lofty expectations. As a result, managers who did not have exposure to this group of stocks, in particular value managers, suffered significant underperformance for periods or the whole of 2018. In its typical capricious way, the market turned negative on the high-growth stocks in the final quarter. As we head into 2019, we believe active management will play a critical role in navigating a more volatile and uncertain equity market.
The Trust’s concentrated, best ideas approach should be well positioned to take advantage of volatile markets, as investors often overreact when facing escalated volatility/market weakness, creating pockets of opportunities for active management. The Trust’s managers are skilled at identifying companies with strong growth and/or high-quality characteristics selling at discount to intrinsic value, and we have already heard from several of our managers that markets are now starting to present opportunities.