Over the last year we've witnessed fed rate hikes, technological advancements, and market headwinds that have effected the financial industry in myriad ways. In this article, FactSet's experts weigh in on the trends that have left their mark on 2018.
Econ: GDP Growth Surge, Fed Rate Hikes, and Tariffs
There were three big stories in 2018 pertaining to the U.S. economy: the surge in GDP growth following the December 2017 tax cut, a steady pace of Fed rate hikes, and tariffs. Quarterly GDP growth peaked in the second quarter and has been waning since; 2Q annualized quarter-over-quarter growth of 4.2% was followed by 3.5% 3Q growth, and analysts surveyed by FactSet expect 4Q growth to slow to 2.7%. For the year, the economy is projected to grow by 2.9%, the fastest pace since 2015.
Faster GDP growth has led to tight labor markets and rising inflation. In response, the Fed increased interest rates four times during the year, boosting rates by a cumulative 100 basis points. The pace of hikes is expected to slow in 2019, with just two anticipated. Not only are higher interest rates impacting the economy, U.S. trade tariffs instituted throughout the year are hurting growth, both domestically and abroad.
Earnings: Highest Annual Earnings Growth for S&P 500 Since 2010
As of today, the estimated earnings growth rate for CY 2018 is 20.4%. If 20.4% is the final growth rate for the year, it will mark the highest annual earnings growth for the index since 2010 (39.6%). All 11 sectors are projected to report year-over-year growth in earnings, led by the Energy, Materials, and Financials sectors. The tax reform law passed in late 2017 has been a significant contributor to earnings growth for the index in 2018, as the corporate tax rate was lower in 2018 relative to 2017. The estimated (year-over-year) revenue growth rate for CY 2018 is 8.9%. If 8.9% is the final growth rate for the year, it will mark the highest annual revenue growth for the index since 2011 (10.6%). All 11 sectors are expected to report year-over-year growth in revenues, led by the Energy, Communication Services, and Materials sectors.
While 2018 was memorable for a number of reasons (France winning the World Cup, midterm elections, my return to the U.S. after three years abroad…I can keep going), I will remember it as the year of Fed transparency, with Federal Reserve Chair Jerome Powell and team continuing down the path of rate normalization and the unwinding of quantitative easing mapped out by his predecessor. Interest rates were all over the place, however a risk-off environment at year-end finds them settling around levels last seen at the end of January’s run up. We also saw part of the yield curve invert for the first time since 2007. Only time will tell whether or not this front runs a broader inversion. It was a terrible year for hard currency EM debt, as protectionism and a stronger dollar ran roughshod across the space while impressive US Government spending laid a base for a future inflationary environment. In good news, we learned that corporate defined benefit plans are currently averaging a funding ratio of over 90%, meaning that corporations can de-risk their balance sheets using LDI techniques.
Activism: Elliott Management Corporation's Big Year
In 2018, Elliott Management Corporation launched 21 activism campaigns this year (one with Bluescape Resources, the rest alone) which is the highest on record, and almost triple what Starboard, a very active activist themselves, launched in 2018. Furthermore, this is the fourth consecutive year they have led major activists in terms of campaign volume. In those four years, Elliott’s 62 campaigns ran alone (not part of a larger group) and were almost double that of GAMCO Asset Management, second place on the SharkWatch50 with 33 campaigns.
Performance: The Growth of Technology in the Investment World
Christophe Volard, Senior Vice President, Director of Performance Measurement
The investment management industry has been through many changes in the past year in multiple areas, especially how to add new asset classes, and how to manage regulations. So, obviously, all that has an impact on the performance teams. If you want to highlight just a few trends that we see in performance, the first is the pressure that they are under due to the cost and margin reductions. Generally, we tend to say that they have to do more with less, more meaning that they have to deal most of the time with more portfolios, more asset classes, more complexity, more frequency of reporting, and all that within shorter timeframe. This means that the performance teams have to look for efficiency every day and focus on where they can add value. So, in order to do that, they have to be equipped with performance systems that will help them for getting that efficiency.
One of the biggest challenges our performance teams are experiencing is the downstream distribution of performance data. In order to do that, they have to be confident in the results, in the performance numbers that they can make available to their clients.
The year 2018 was dominated by the launch of MIFID II and the outcome of Brexit negotiations. At first blush, MIFID II seemed to go off without a hitch but as time proceeded, data problems arose prompting ESMA, amongst other measures, to publish and maintain on an ongoing basis a list of recalcitrant firms who had failed to make adequate regulatory disclosures. A number of legislative tweaks to the MIFID II package were also required elsewhere, including amendments to the systematic internalizer and tick size regimes. Meanwhile, the impact of MIFID II research unbundling rules led to a steep drop in consumption, industry commentators observed significant non-compliance with best execution requirements and in the trading arena, periodic auctions emerged, prompting a degree of controversy. Finally, in September, the full systematic internalizer regime went live, which was also accompanied by data problems.
The failure of Brexit negotiations, meant the slow diaspora from the City of London to the Continent continued apace. Meanwhile, MIFID III became a Brexit battleground with strengthened third country provisions a prime focus for ESMA and the Commission. Outside of these two box-office developments, 2018 also saw the GDPR go-live, the Senior Managers Regime swing into further effect, the introduction of the Benchmark Regulation, the application of the Money Markets Fund Regulation to new funds, the Insurance Distribution Directive and Payment Services Directive II come into effect, several amendments to the Solvency II regime enacted and the fifth Money Laundering Development enter the Official Journal, among many, many other developments.
Risk: The Unification of Risk Management Workflows, and the (Continued) End of Normalcy
One of the trends that we've seen of the past year is the increased need for a single solution that caters to all parts of the risk management workflow, from market risk to credit risk to liquidity risk, and this is really driven by consolidation in the industry as well as increased regulatory requirements. Another trend that we're seeing at our clients is the rise of portfolio solutions teams, which typically sit inside of large asset managers and has a very unique workflow around robust risk management solutions.
For many decades, up until the early signs of market tremors in 2007, financial markets were characterized by extended periods of “normal” behavior, followed by shorter “stressed periods” exhibiting higher probability of extreme events. This is no longer the case.
For most markets, the “normal” periods are a thing of the past. Contributing to that are both factors related to macro-economic, political, and other global developments and others that stem from the irreversible evolutionary developments of the financial markets.
In 2018 we saw that asset returns themselves are no longer predominantly fundamentally driven. Depending on the investment horizon, market micro-structure or behavioral factors may play a determinant effect. The market landscape is more and more defined by the behavioral reactions of market participants to news and the resulting re-positioning towards anticipated risks. Political uncertainties, environmental impact, and technological disruptions can cause both short-term turbulence and long-term structural breaks.
Wealth: Self-Service Tools for Portfolio Optimization
Optimizing advisory with digital technology. Private wealth clients demand for technology augmented advice and personalized self-service tools – in particular around portfolio optimization and access to third-party products. 82% expect their advisor to enhance online capabilities over time.
Improving competitiveness through visualization. Maybe the most shocking to me. Even in the coveted area of ultra-personalized services to the High-Net-Worth community, the availability of personalized online services is lowest. No matter how you sliced the data, always between 50 and 80% of respondents stated that content and functionality provided online was not tailored to their individual situation.
Empowering client service with personalization. Contrary to the near absolute conviction of traditional wealth advisory about the strict privacy demands of their clients, a large number of their customers (in particular High-Net-Worth and Ultra-High-Net Worth clients) are happy to provide nearly any and all personal data in return for better services and advice tailored to their personal situation.
ESG: Improving Performance with Socially Responsibly Strategies
One of the historical criticisms of ESG or SRI investing is that an investor must sacrifice performance in exchange for investing in companies that behave in alignment with their personal values. One of the biggest trends I’ve seen in 2018 regarding ESG investing is the growing belief in the ability for these concepts to be long-term producers of alpha in addition to being socially responsible. Advances in technology have opened up ESG investing to sophisticated Machine Learning and Natural Language Processing methods that allow investors to keep a real-time finger on the pulse of a company’s ESG profile. Providers like Arabesque, RepRisk, and Truvalue Labs have done a lot of the heavy lifting, exposing these capabilities to firm’s who may not have previously had the inclination to do it themselves. Applying these more advanced approaches to ESG/SRI has allowed firms to capture excess performance while also meeting a socially responsible mandate.
Alternative Data: A Field Likely to Make Waves in the Near Future
In 2018 there was a vast increase of ESG ratings. By some estimates, there are more than 120 ratings organizations offering over 500 products. It is clear, the materiality of sustainability information is now recognized across global markets, and has become mainstream.
Furthermore, considering the significance of data, last year we highlighted the following statistic: within the next hour alone, we will generate 21.6 million tweets, 8.5 billion emails, 34,200 new websites, and 144 million Google searches. Ours is an age where data shapes almost every aspect of life. Through rapid advancements in technology, big data has disrupted entire industries, influencing how we work, how we consume, and how we view the world.
Interest in alternative data rose precipitously through 2018, as evidenced by the number of mentions in financial services press releases. Unfortunately, alternative data remains a vastly misunderstood field. Most asset managers are still struggling to handle traditional market data, so they have yet to fully embrace alternative data. Alternative data cannot be tested the same way as market fundamentals and should be viewed as more akin to research. This could free asset managers to evaluate alternative data as not only additive to existing models, but as a supplement to improve model efficiency.
Although references to alternative data in financial services corporate communications rose throughout 2018, financial services companies barely referenced alt data in their earnings calls. In fact, earnings calls by both Industrials companies and Information Technology companies referenced alternative data far more frequently. This suggests that firms in other sectors are looking for ways to monetize their data, as the alternative data market continues to heat up in concert with growing interest in AI.
In 2018, large financial institutions spent a great deal marketing their AI capabilities, giving the appearance that they have teams in place actively using alternative data and AI-derived signals. In reality, the asset management industry is just beginning to get comfortable with alternative data and has barely begun to understand AI. Heading into 2019, we expect that institutions who have been transparent about their level of technical sophistication and have invested in technical infrastructure—rather than marketing—will separate themselves from the pack and realize the benefits of alternative data and AI.