Sophie Meatyard: The winners and losers of 2018

Defensives finish the year strong after two violent sell-offs as investors eschew the ‘buy the dip’ mentality

This year has been one of ups and downs centred on two sell-offs sandwiching a steady summer, so where does this leave us going into next year? To answer this, we’ll need to delve a little deeper into the shifts in global investor sentiment seen throughout the year.

There have been a number of driving factors for the two sell-offs this year, namely fears of slowing global growth, trade tensions between Washington and Beijing and political turmoil in the UK thanks to Brexit.

Despite this seemingly ongoing negative stream of news, economic data coming out of the US remains solid and, although the Fed expects economic growth to slow in the coming year, sentiment for 2019 remains positive. Rumblings of a recession seem to be pointing towards 2020/21.

The sell-off in the latter part of 2018, specifically in October, was the most violent. The worst-hit sectors were energy, materials and consumer discretionary, which lost 8.2%, 7.6% and 7.3% respectively. Conversely, sectors with defensive characteristics weathered the storm the best – utilities returned 1.4% while consumer staples gained a modest 0.6%.

However, this rotation into defensives wasn’t the first of the year.

Although March was a more indiscriminate sell-off that saw almost all sectors affected, the same defensive industries fared better than their cyclical and sensitive counterparts. Utilities were up 2.2% and consumer staples lost less than the more economically-sensitive financials and materials sectors. This is a stark contrast to the risk-on scenario of 2017 in which defensives underperformed.

In the final quarter of the year it has so far been the defensive utilities, consumer staples and infrastructure sectors that are performing well while financials and materials have suffered.

Within the financials sector, banking stocks are the laggards as they tend to benefit from a rising interest rate environment where they can earn more on the credit they issue to customers.

Being a cyclical sector, the performance of financials is highly correlated to the economic activity of a country. The sector has been hurt by expectations of a more dovish Fed, while concerns surrounding yield curve inversions – sometimes considered to be an indicator of the next recession – have increased.

Other areas that are suffering include the industrials and retail sectors, the former as a result of the ongoing US-China trade dispute and the latter because consumers are spending less on discretionary items.

If we look at year-to-date performance across all sectors, unsurprisingly, it’s the defensives that come out on top with utilities and healthcare industries being the winners. At the bottom end, the sectors underperforming their peers over the year were materials, financials and energy.

This rotation into defensive equities suggests investors are preparing for a downturn and choosing to invest their money in those industries that are more likely to protect their capital.

Another sign of this shift in investor sentiment can be seen by the increased flows into ‘safe haven’ assets – those which tend to be popular for nervous investors. One such asset – gold – is up 4.7% this quarter and is at its highest level in five months, thanks in no small part to the aforementioned expectations of a more dovish Fed.

At a sector level, analysts are most optimistic about energy, healthcare, communication services and materials, while they are most pessimistic about the consumer staples, utilities and real estate sectors, according to Factset. This view is largely driven by valuations with analysts seeing room for growth in the former and potential for profit-taking in the latter.

Yet, in a market that remains jittery and in which investors appear to have lost their ‘buy-the-dip’ mentality, the analyst opinions on various sectors is perhaps no longer relevant.

Sophie Meatyard is a fund analyst at FE Invest

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