January 2019
Dear Fundholder:
After a promising start to 2018, financial markets were battered by a combination of forces. Emerging markets, Europe and the U.K. (2017’s best performers) saw a reversal of fortune and became the hardest-hit areas of 2018 as they struggled with ongoing geopolitical uncertainty. Concerns about the U.S.-China trade relationship and Great Britain’s future association with the European Union raised unwelcome implications for global economic conditions. Financial markets, which prefer quantifiable risks, responded accordingly.
Last year’s downturns helped alleviate elevated stock market valuations, which were SEI’s foremost concern at the beginning of 2018. SEI believes attractive valuations on stocks priced for bad news opens up a path for upside surprises to reset market sentiment. Positive developments on hot-button issues—from international trade, to Brexit, Federal Reserve (Fed) policy, U.S. dollar strength, Chinese lending and elsewhere—could serve as catalysts for a new rally. Working through these major themes, SEI believes some are more likely to provide good news than others.
- The U.S.-China economic relationship will likely continue to deteriorate over time as the Trump administration seeks a way to level the playing field. If this proves true, then SEI expects the Chinese government to get more aggressive in easing lending constraints, which has historically driven gains in emerging-market equities.
- Regarding the U.K.-EU divorce, SEI believes the real decision now is between the Prime Minister’s Brexit deal or no-Brexit at all. A no-Brexit scenario could be attained either by the U.K. government revoking Article 50 or, more likely, a second referendum. Expect volatility as the late-March Brexit date nears.
- SEI is penciling in just one Fed rate increase in 2019, and perhaps one in 2020—less than the Fed but more than market expectations. The important thing to remember is that the central bank is adopting a wait-and-see approach to monetary policy.
- The U.S. dollar rally could come to a halt. U.S. economic and earnings performance should converge with international markets, and investment capital could flow away from the U.S. and back into the world if good news comes to pass. A dovish turn in Fed policy would also weigh on the dollar. Commodities and emerging markets would be the primary beneficiaries of a weaker greenback.
- Points of strength for the U.S. economy include the improving financial position of U.S. households as labor markets tighten and real wage growth accelerates, and increased government spending. Fiscal policy will not be the strong catalyst for growth that it was in 2018, but the impact of political gridlock should still be mildly expansionary.
While investors are currently unnerved by the concerns of the day, SEI believes the global economy will continue to grow in 2019, and sees another important risk-on opportunity developing in equities and other risk assets. If consistent with investors’ strategies, a rebalancing of assets back toward undervalued equity classes would be an appropriate and timely response.
SEI has been a long-time advocate of the benefits of diversification—a position we maintained in recent years even as narrowly focused markets rewarded U.S. stocks (most notably in the technology sector) to the detriment of diversified strategies. Today, central banks are winding down the flood of liquidity that accompanied interest-rate cuts and quantitative-easing efforts during and in the decade following the global financial crisis. The extended boost to securities prices (regardless of their valuations) is reversing, dampening much of the unrestrained momentum witnessed in recent years and compelling investors to begin differentiating between higher- and lower-quality companies again. As active investment managers, SEI believes that diversification and sound investment discipline will show their value over the next several years for investors who maintain their long-term strategic allocations.
During periods of market volatility like the one we have been going through, we make sure to remind investors about the importance of sticking with a strategic and disciplined approach to investing that is consistent with goals, objectives and risk tolerances. Diversification is the key to that approach and the construction of investment portfolios for the Delaware Community Foundation is consistent with SEI’s long-term capital market assumptions.
Sincerely,
Glenn Harris
SEI Client Portfolio Manager/
Outsourced Chief Investment Officer to the DCF