Global Outlook, CORONAVIRUS DERAILS GLOBAL ECONOMY
London. April 2020
The threat from the coronavirus (COVID-19) has developed into a global health pandemic of a scale not seen since the Spanish flu, around a hundred years ago. To date, there have been more than 1 million confirmed cases globally and over 50,000 deaths. The trajectory of infections is still steeply upwards, with the US becoming the latest epicentre of this global crisis.
Financial Markets have displayed a high degree of volatility in response to the rapid spread of the coronavirus. The VIX (Wall Street’s ‘Fear’ index) surged to its highest level since the Great Financial Crisis, and our own Cross-Asset Risk Index confirmed a degree of investor pessimism not seen since October 2008, when the global financial system was close to collapse. While equity markets have recovered from their lows, the VIX index remains above 45 (a level that is 3 standard deviations above average) for its 20th consecutive session, suggesting the market remains concerned about volatility.
Having enforced strict lockdown measures to reduce the spread of the virus, rightly prioritising the human cost over the economic consequences, governments globally have announced unprecedented fiscal stimulus packages, including loan guarantees for businesses and income protection for workers, to cushion the economy during this hopefully temporary shock. Central banks have also significantly loosened monetary conditions to ease financial market stress and help maintain the flow of credit to firms. The key measure of success for policy makers globally will be avoiding any significant longer-term damage to their economies.
The economic implications of the crisis are still unknown. According to many forecasters, including the IMF, a global recession now appears a near certainty. This is supported by recent survey evidence showing national lockdowns behind record declines in activity in the US, UK and Euro Area. The immediate impact on workers is also increasingly stark, with claims for income support spiking higher across countries, raising fears about surging unemployment. Most official data will remain less timely for now, so alongside surveys, close attention should be paid to officials and Q1 business updates to gauge the economic impact.
London. April 2020
The threat from the coronavirus (COVID-19) has developed into a global health pandemic of a scale not seen since the Spanish flu, around a hundred years ago. To date, there have been more than 1 million confirmed cases globally and over 50,000 deaths. The trajectory of infections is still steeply upwards, with the US becoming the latest epicentre of this global crisis.
Financial Markets have displayed a high degree of volatility in response to the rapid spread of the coronavirus. The VIX (Wall Street’s ‘Fear’ index) surged to its highest level since the Great Financial Crisis, and our own Cross-Asset Risk Index confirmed a degree of investor pessimism not seen since October 2008, when the global financial system was close to collapse. While equity markets have recovered from their lows, the VIX index remains above 45 (a level that is 3 standard deviations above average) for its 20th consecutive session, suggesting the market remains concerned about volatility.
Having enforced strict lockdown measures to reduce the spread of the virus, rightly prioritising the human cost over the economic consequences, governments globally have announced unprecedented fiscal stimulus packages, including loan guarantees for businesses and income protection for workers, to cushion the economy during this hopefully temporary shock. Central banks have also significantly loosened monetary conditions to ease financial market stress and help maintain the flow of credit to firms. The key measure of success for policy makers globally will be avoiding any significant longer-term damage to their economies.
The economic implications of the crisis are still unknown. According to many forecasters, including the IMF, a global recession now appears a near certainty. This is supported by recent survey evidence showing national lockdowns behind record declines in activity in the US, UK and Euro Area. The immediate impact on workers is also increasingly stark, with claims for income support spiking higher across countries, raising fears about surging unemployment. Most official data will remain less timely for now, so alongside surveys, close attention should be paid to officials and Q1 business updates to gauge the economic impact.
Global Investment Outlook 2020
London. January 2020.
2019 was a very challenging year given the sharp slowdown in growth and the sharp rise in recession fears. Some of this uncertainty will linger into 2020, where we at FieldInvest continue to expect a more challenging policy-making environment. Trade and economic uncertainty as well as political and geopolitical risk, will persist in the background throughout 2020, frustrating investment plans and business sentiment across industries.
In Europe
Investing in 2020 will mean navigating an uneven global recovery and uneven valuations. Here are our key investment themes for the year ahead.
At first glance, the investment outlook for 2020 should be straightforward. Morgan Stanley economists believe the simultaneous easing of trade tensions and monetary policy will offer a late-cycle lift for the global economy. Their forecast calls for 3.2% global GDP growth next year, followed by 3.5% in 2021.
The so-called 'sequencing the cycle' strategy means being more aggressive in better-valued markets with early-cycle upside and more defensive in pricey markets with less room to run. In reality, the picture is distorted by high valuations in many markets, disparate regional cycles and a recovery that relies on continued progress in trade negotiations.
This “sequencing the cycle” strategy means being more aggressive in better-valued markets with early-cycle upside and more defensive in pricey markets that have less room to run. It also means staying flexible. The fact that this outlook could be changed materially by tariff decisions suggests that an outsized level of nimbleness may be required.
Broadly speaking, U.S. risk assets are already fairly valued, but there are opportunities below the index, and in other regions and asset classes around the world.
Here are some key themes for 2020.
As a turbulent year for the global economy, financial markets, and politics recedes in the rear-view mirror, we look ahead into 2020, mapping out both the likely path and the potential roadblocks for the economy and investors. This outlook draws on work by Pimco.
Last year was not for the fainthearted: Global growth was “synching lower” and entered a “window of weakness,” the U.S.–China conflict and Brexit uncertainty provided a dark mood, climate concerns took centre stage amid extreme weather around the globe, and protests against the political establishment reverberated through Hong Kong, Lebanon, Chile, Ecuador, and many other places. And yet, spurred by global monetary easing led by the U.S. Federal Reserve’s dovish pivot in early 2019, both equities and bonds had a year of very positive returns.
Based on the discussions during and following last month’s forum, here are our key macro themes for 2020 and how we position portfolios for each of them.
‘TIME TO RECESSION’ HAS INCREASED
Recession risks, which had been elevated during the middle part of 2019, have diminished in recent months, helped by additional global monetary easing, a trade truce between the U.S. and China, better prospects for an orderly Brexit, and early signs of a rebound in the global purchasing managers’ indices (PMIs). This assessment is corroborated by an easing of the 12-month-ahead recession probabilities for the U.S. estimated by our various U.S. recession models.
As a consequence, we are now more confident in our baseline forecast that the current window of weakness for global growth will give way to a moderate recovery during 2020. World GDP growth, which has been slowing over the past two years, has yet to bottom. However, PIMCO’s World Financial Conditions Index, which tends to lead output growth, has been easing (rising) in recent months.
Another factor underpinning a likely pickup in global growth this year is the supportive stance of fiscal policy in major economies such as China, Europe, and Japan. With fiscal and monetary policy now working in the same direction – further easing – in almost all major economies, the outlook for a sustained economic expansion over our cyclical horizon has improved.
We expect to run a little less duration in our portfolios, with duration close to flat as our starting point and adjusted from there depending on the balance of risk positions in the portfolio. We want to have a constructive approach, with positive carry versus benchmarks, in order to seek to generate income and outperform in the baseline scenario. But we will do this with a bias toward higher-quality positions, a very close focus on portfolio liquidity, and a preference for a diversified approach to generating income. We prefer not to rely excessively on generic corporate credit given concerns over valuations and market liquidity, and the potential for poor performance amid a worse macro outcome than we are expecting or in the event of an overall rise in market volatility in which investors demand a higher risk premium for investing in corporate credit. Within credit, we expect to favour financials over industrials. In asset allocation portfolios, we expect to have a modest overweight to equities, with profit growth likely to provide support in spite of fairly elevated valuations.
Yet again, the Fed and other major central banks have helped to extend the global expansion by adding stimulus in response to rising recession risks. However, last year’s easing of monetary policy comes at a price: Whenever the next economic downturn or major risk market drawdown hits, policymakers will have even less policy capacity to manoeuvre, thus limiting their ability to fight future recessionary forces. Thus, while “time to recession” has likely increased with last year’s monetary easing, so has “loss given recession.”
To be sure, this is not a criticism of central banks’ easing actions last year. Hoarding rather than using the policy toolkit is usually not a good idea in the face of rising recession or deflation risks. Rather, these call for aggressive and pre-emptive action early on to nip them in the bud. This is what both the Fed and the European Central Bank (ECB) attempted last year in response to rising risks and uncertainties, and the first indications are that they were successful in countering these risks. Still, an inevitable consequence of cutting rates further toward the effective lower bound is that there is now less monetary policy space available for future action.
A common response to the above is that while monetary policy has less space, fiscal policy can and should step in and save the day whenever the next recession looms. After all, low interest rates coupled with central banks’ ability and willingness to purchase (more) government bonds create more fiscal space for governments. In theory, we agree and have in fact argued for some time that fiscal policy is likely to become more proactive in the future. In practice, however, it is unlikely that governments and parliaments are able to diagnose recession risks early enough and, even if so, implement fiscal easing in time to prevent a recession, given the slow way in which political processes usually work. Thus, central banks will still have to be the first responders in the next crisis and, again, will be more constrained than they have been in the past.
Another way last year’s monetary easing may increase “loss given recession” is that the combination of a longer expansion and a longer period of even lower rates and “QE infinity” (i.e., central bank asset purchases, or quantitative easing, with no clear end date) incentivizes companies and households to increase leverage, which could come back to haunt them and their creditors in the next downturn.
We will tend to favour U.S. duration over global alternatives, given the relative value and potential for capital gains in U.S. Treasuries and the scope for further Fed easing in the event of a weaker-than-expected macro outcome. While we are broadly neutral on the U.S. dollar versus other G10 currencies, we generally will favour long yen positions in accounts where currency exposure is appropriate, reflecting the combination of what we believe is cheap valuation and the risk-off nature of a long yen position (which can be a proxy for duration exposure). In credit, as well as the overall cautious stance on generic credit risk, we expect to favour short-dated, default-remote “bend but don’t break” corporate exposures, being extra cautious in the current stage of the credit cycle of what fits into this category.
Another factor that could hold back U.S. animal spirits and growth this year would be a possible increase in political uncertainty ahead of the U.S. elections, particularly if progressive high-tax, high-regulation Democratic candidates gain more support during the primaries. This would most likely weigh on business sentiment and investment spending and could lead to a tightening of financial conditions via lower expected equity returns.
Taken together, U.S. growth momentum may lag global growth momentum at least for some time during the first half of 2020.
In currency strategy, we look to be overweight a basket of emerging market currencies versus the U.S. dollar and the euro. We will watch closely for other opportunities to be long G-10 currencies versus the U.S. dollar if we see more evidence of a relative shift in momentum from the U.S. to the rest of the world.
While the consensus forecast is for benign inflation in the advanced economies over our cyclical horizon, medium-term upside risks outweigh downside risks, especially given how little inflation is priced into markets.
One reason is that labour markets have continued to tighten, and wage pressures, though still very moderate given the low level of unemployment, have been picking up recently. If unemployment falls further as economic growth recovers this year, wage pressures are likely to intensify over time, and firms will find it easier to pass on cost increases as demand improves.
Also, with fiscal policy likely to become more expansionary over time, in line with our view that “fiscal is the new monetary,” nominal demand should be better supported, especially if central banks play ball and don’t aim to offset fiscal easing with monetary tightening as the Fed did in 2018.
Last but not least, after many years of missing their inflation targets on the downside, virtually all major central banks seem to prefer inflation (the devil they know) over deflation (the devil they don’t know). While any changes resulting from the Fed’s ongoing and the ECB’s upcoming strategic review are likely to be evolutionary rather than revolutionary, we expect a nod toward average inflation targeting in the U.S., and a more symmetric 2% inflation target or target band centred around 2% in the euro area, implying a higher tolerance by two major central banks for potential inflation overshoots.
Against this backdrop, and despite the expected global growth recovery this year, we see the major central banks largely on hold this year and expect the bar for tighter policy to be generally higher than the bar for further easing. While discomfort with negative interest rates in Europe is rising given the unpleasant side effects, the ECB is very unlikely to exit until well beyond our cyclical horizon.
Expect curve steepening in the U.S. and in other countries, reflecting valuations but also reflecting the combination of front ends anchored by central banks – that will be reluctant to tighten policy – and the potential for higher inflation expectations to be priced in further out the curve. Curve steepening positions should also provide our portfolios with some cushion given the rise in U.S. government deficit and debt and the possibility that, over time, markets will demand more term premium in the event of further deterioration in the fiscal outlook. U.S. Treasury Inflation-Protected Securities (TIPS) look attractive on a valuation basis and, given the high bar for the Fed to hike rates, even in a somewhat stronger environment. While the outlook for inflation is subdued, the balance of risks is toward a higher inflation outlook than the relatively depressed level priced into TIPS break-evens.
While most have an economic outlook of a moderate pickup in global growth amid supportive monetary and fiscal policy is relatively benign, we remain cognizant of the potential for significant bouts of volatility caused by geopolitics and national politics around the world.
While a limited Phase 1 trade deal between China and the U.S. is in the making, relations between the established power U.S. and the rising power China remain fragile and tensions could easily erupt again during this year.
Another area of focus this year will be the U.S. elections in November. Risk markets will pay close attention as the field of Democratic candidates for the presidency narrows during the primaries.
Moreover, the recent wave of protests against the political establishment across many emerging market economies may spread further, especially as potential growth in many of these economies has downshifted, which increases the dissatisfaction with governments and sharpens the focus on income and wealth inequality.
While the baseline outlook for 2020 looks positive, we also recognize risk premia has been compressed by central bank action, leaving little cushion in the event of disruption. We see a range of political and geopolitical risks in addition to the potential for macro surprises, central bank exhaustion, and rising volatility. As well as a close focus on liquidity management, careful scaling of investment positions, and caution on generic credit, we will look to have somewhat lower weight on top-down macro trades, to keep powder dry and potentially go on the offensive in a more difficult investment environment.
A view on asset allocation is often rooted in an assessment of where we are in the cycle. Early in the cycle, valuations are cheap, policy accommodative and the economy has ample spare capacity to grow. It’s often a good time to take risk.
Conversely, late cycle is usually a good time to take chips off the table. When the economy is displaying signs of exuberance or overheating, higher interest rates usually put an end to the party.
It’s proving much harder to navigate markets today based on an assessment of the cycle. The map is far from clear. Unemployment rates – often a key navigation tool – are near record lows in most parts of the developed world, suggesting the economy is very late cycle. However, there are very few other signs of classic late-cycle economic exuberance. Neither business nor consumer spending looks toppy. Indeed, the US consumer is looking remarkably prudent: the savings rate, which often falls sharply late in the cycle, is pretty high. And inflation is certainly not suggesting the global economy has reached its limits. In fact, central banks are preoccupied with the idea that inflation remains too low and may be getting stuck. Rather than trying to tame the expansion, the primary focus for central banks is how to gee it up.
This makes it very hard to say confidently how much time is left on the economic clock.
A resolution in the US-China trade conflict, a Brexit solution, and an easing of tensions in Hong Kong, Chile and Turkey could fuel a turnaround in business sentiment and a reacceleration in activity in 2020. Against a backdrop of muted inflation, interest rates could stay low. This would be a good environment for risk assets.
But it is more likely, in our view, that geopolitical risk will linger. We think the trade conflict is unlikely to be fully resolved. Surveys suggest the US electorate believes the president is right to address unfair trade practices, while on certain areas of the disagreement – such as China’s state-led subsidies for its tech sector – there is seemingly no common ground. China believes in industrial policy, the US does not.
The US administration does seem to appreciate that it needs to get the balance right between keeping the agenda alive and not damaging the US expansion, hence the recent more conciliatory tones. We’ll see in the coming months whether this more measured approach does much to boost corporate sentiment. Companies have been spooked, and are likely to remain reluctant to invest, which will limit the extent to which manufacturing bounces back through the course of 2020. This reluctance appears to be filtering into hiring intentions.
While equity investors have earned 20% year-to-date, most of these gains occurred by April 30, as markets rebounded from the sharp declines of fourth quarter 2018. From September 30, 2018, through October 31, 2019, global equities have returned just 5%. Equity valuations remain close to last year’s levels, as equity appreciation has paced 4.7% global earnings growth. At the same time, ten-year G4 sovereign bond yields have fallen significantly, credit spreads have tightened, and lending standards have deteriorated.
Diversification remains central in 2020. Even with near-zero yields, sovereign bonds can prove useful in a market downturn, and we favour them over liquid credits. Within liquid credit, we prefer structured credit and trading-oriented distressed strategies that could capitalize on market volatility.
Investors should rebalance US equities and growth stocks, which have outperformed during this market expansion, to at least a neutral allocation. Should the expansion continue, the overvalued US dollar may soften amid relatively loose monetary policy conditions in the US, boosting non-US equities. Further, softening growth in China, Germany, and Japan have dragged down US growth. These countries are further ahead in the economic cycle than the US and may stabilize before it does, providing the catalyst needed for global ex US equities to outperform. Improved macro conditions would also support value stocks over growth stocks, where relative valuations have become extremely stretched. Select private investment strategies remain appealing. Secondary funds and direct transactions offer distinct advantages at this stage of the cycle, given their discounted pricing and more immediate return of capital.
Finally, as we enter 2020, investors should consider what trends may be most consequential over the next decade. Slower economic growth, deteriorating developed markets demographics, and low productivity growth lift the appeal of less economically sensitive investments often found in private credit opportunities. Investors should boost their portfolios’ resilience to climate change and social inequality challenges through private investments in areas such as climate change mitigation and adaptation solutions, education and workforce development, affordable housing, and financial inclusion. Private real assets also offer opportunities to benefit from secular trends, most notably urbanization, changing demographics, and technological innovation.
Geopolitical tensions and central bank easing will be the key factors to look out for as gold continues to trend above last year’s peak of $1,553, the highest level since 2013. both the threat of a military conflict with Iran and trade disputes with China are likely to remain powerful drivers for the remainder of the year.
The former had spiked gold to a seven-year high of over $1,600 a mere week into 2020, while the latter acted as a consistent source of support throughout last year.
Besides geopolitical tensions, loose central bank policies should keep pushing gold prices up just as they had for the better part of 2019. The Fed could not only slice interest rates to zero to combat a possible recession, but also allow for a period of high-running inflation, both of which would act as major sources of gold’s gains. Uncertainty will continue dominating investor sentiment and keep driving the heavy safe-haven buying seen as of late. Besides tensions with the Middle East, the analysts cited the coming U.S. presidential elections as another potential source of high volatility. Furthermore, the team expects central banks to continue supporting gold prices on a grand scale, both through accommodative policies in the midst of weak global growth and through their all-time high bullion purchases.
With so many tailwind, analysts forecast an average of $1,636 this year and expect the metal to climb as high as $1,780.
Regarding other metals, analysts think that silver will continue trailing gold as it moves up, citing strong fundamentals and the correlation with gold as the reasons why silver will push to $21 and average $18.50 this year.
Summary
London. January 2020.
2019 was a very challenging year given the sharp slowdown in growth and the sharp rise in recession fears. Some of this uncertainty will linger into 2020, where we at FieldInvest continue to expect a more challenging policy-making environment. Trade and economic uncertainty as well as political and geopolitical risk, will persist in the background throughout 2020, frustrating investment plans and business sentiment across industries.
In Europe
- Eurozone Growth To Stabilise, But Risks To Remain Elevated
- Trade Uncertainty Drag To Persist In 2020
- Changes In The EU To Exacerbate Divisions
- Limits Of Monetary And Fiscal Policy In The Eurozone
- Labour Market Gains In CEE Set To Lose Momentum
- Geopolitical And Policy Risks To Overshadow Hunt For Yield In Ukraine, Russia And Turkey
Investing in 2020 will mean navigating an uneven global recovery and uneven valuations. Here are our key investment themes for the year ahead.
At first glance, the investment outlook for 2020 should be straightforward. Morgan Stanley economists believe the simultaneous easing of trade tensions and monetary policy will offer a late-cycle lift for the global economy. Their forecast calls for 3.2% global GDP growth next year, followed by 3.5% in 2021.
The so-called 'sequencing the cycle' strategy means being more aggressive in better-valued markets with early-cycle upside and more defensive in pricey markets with less room to run. In reality, the picture is distorted by high valuations in many markets, disparate regional cycles and a recovery that relies on continued progress in trade negotiations.
This “sequencing the cycle” strategy means being more aggressive in better-valued markets with early-cycle upside and more defensive in pricey markets that have less room to run. It also means staying flexible. The fact that this outlook could be changed materially by tariff decisions suggests that an outsized level of nimbleness may be required.
Broadly speaking, U.S. risk assets are already fairly valued, but there are opportunities below the index, and in other regions and asset classes around the world.
Here are some key themes for 2020.
- Recession risks have diminished, and we are more confident in our baseline forecast of a moderate recovery in global growth this year.
- But monetary policymakers now have even less space left to guard against future recessions.
- Thus, while “time to recession” has likely increased with last year’s monetary easing, so has “loss given recession.”
- Considering the outlook, we seek to invest with a bias to higher-quality positions, a very close focus on portfolio liquidity, and a diversified approach to generating income.
As a turbulent year for the global economy, financial markets, and politics recedes in the rear-view mirror, we look ahead into 2020, mapping out both the likely path and the potential roadblocks for the economy and investors. This outlook draws on work by Pimco.
Last year was not for the fainthearted: Global growth was “synching lower” and entered a “window of weakness,” the U.S.–China conflict and Brexit uncertainty provided a dark mood, climate concerns took centre stage amid extreme weather around the globe, and protests against the political establishment reverberated through Hong Kong, Lebanon, Chile, Ecuador, and many other places. And yet, spurred by global monetary easing led by the U.S. Federal Reserve’s dovish pivot in early 2019, both equities and bonds had a year of very positive returns.
Based on the discussions during and following last month’s forum, here are our key macro themes for 2020 and how we position portfolios for each of them.
‘TIME TO RECESSION’ HAS INCREASED
Recession risks, which had been elevated during the middle part of 2019, have diminished in recent months, helped by additional global monetary easing, a trade truce between the U.S. and China, better prospects for an orderly Brexit, and early signs of a rebound in the global purchasing managers’ indices (PMIs). This assessment is corroborated by an easing of the 12-month-ahead recession probabilities for the U.S. estimated by our various U.S. recession models.
As a consequence, we are now more confident in our baseline forecast that the current window of weakness for global growth will give way to a moderate recovery during 2020. World GDP growth, which has been slowing over the past two years, has yet to bottom. However, PIMCO’s World Financial Conditions Index, which tends to lead output growth, has been easing (rising) in recent months.
Another factor underpinning a likely pickup in global growth this year is the supportive stance of fiscal policy in major economies such as China, Europe, and Japan. With fiscal and monetary policy now working in the same direction – further easing – in almost all major economies, the outlook for a sustained economic expansion over our cyclical horizon has improved.
We expect to run a little less duration in our portfolios, with duration close to flat as our starting point and adjusted from there depending on the balance of risk positions in the portfolio. We want to have a constructive approach, with positive carry versus benchmarks, in order to seek to generate income and outperform in the baseline scenario. But we will do this with a bias toward higher-quality positions, a very close focus on portfolio liquidity, and a preference for a diversified approach to generating income. We prefer not to rely excessively on generic corporate credit given concerns over valuations and market liquidity, and the potential for poor performance amid a worse macro outcome than we are expecting or in the event of an overall rise in market volatility in which investors demand a higher risk premium for investing in corporate credit. Within credit, we expect to favour financials over industrials. In asset allocation portfolios, we expect to have a modest overweight to equities, with profit growth likely to provide support in spite of fairly elevated valuations.
Yet again, the Fed and other major central banks have helped to extend the global expansion by adding stimulus in response to rising recession risks. However, last year’s easing of monetary policy comes at a price: Whenever the next economic downturn or major risk market drawdown hits, policymakers will have even less policy capacity to manoeuvre, thus limiting their ability to fight future recessionary forces. Thus, while “time to recession” has likely increased with last year’s monetary easing, so has “loss given recession.”
To be sure, this is not a criticism of central banks’ easing actions last year. Hoarding rather than using the policy toolkit is usually not a good idea in the face of rising recession or deflation risks. Rather, these call for aggressive and pre-emptive action early on to nip them in the bud. This is what both the Fed and the European Central Bank (ECB) attempted last year in response to rising risks and uncertainties, and the first indications are that they were successful in countering these risks. Still, an inevitable consequence of cutting rates further toward the effective lower bound is that there is now less monetary policy space available for future action.
A common response to the above is that while monetary policy has less space, fiscal policy can and should step in and save the day whenever the next recession looms. After all, low interest rates coupled with central banks’ ability and willingness to purchase (more) government bonds create more fiscal space for governments. In theory, we agree and have in fact argued for some time that fiscal policy is likely to become more proactive in the future. In practice, however, it is unlikely that governments and parliaments are able to diagnose recession risks early enough and, even if so, implement fiscal easing in time to prevent a recession, given the slow way in which political processes usually work. Thus, central banks will still have to be the first responders in the next crisis and, again, will be more constrained than they have been in the past.
Another way last year’s monetary easing may increase “loss given recession” is that the combination of a longer expansion and a longer period of even lower rates and “QE infinity” (i.e., central bank asset purchases, or quantitative easing, with no clear end date) incentivizes companies and households to increase leverage, which could come back to haunt them and their creditors in the next downturn.
We will tend to favour U.S. duration over global alternatives, given the relative value and potential for capital gains in U.S. Treasuries and the scope for further Fed easing in the event of a weaker-than-expected macro outcome. While we are broadly neutral on the U.S. dollar versus other G10 currencies, we generally will favour long yen positions in accounts where currency exposure is appropriate, reflecting the combination of what we believe is cheap valuation and the risk-off nature of a long yen position (which can be a proxy for duration exposure). In credit, as well as the overall cautious stance on generic credit risk, we expect to favour short-dated, default-remote “bend but don’t break” corporate exposures, being extra cautious in the current stage of the credit cycle of what fits into this category.
Another factor that could hold back U.S. animal spirits and growth this year would be a possible increase in political uncertainty ahead of the U.S. elections, particularly if progressive high-tax, high-regulation Democratic candidates gain more support during the primaries. This would most likely weigh on business sentiment and investment spending and could lead to a tightening of financial conditions via lower expected equity returns.
Taken together, U.S. growth momentum may lag global growth momentum at least for some time during the first half of 2020.
In currency strategy, we look to be overweight a basket of emerging market currencies versus the U.S. dollar and the euro. We will watch closely for other opportunities to be long G-10 currencies versus the U.S. dollar if we see more evidence of a relative shift in momentum from the U.S. to the rest of the world.
While the consensus forecast is for benign inflation in the advanced economies over our cyclical horizon, medium-term upside risks outweigh downside risks, especially given how little inflation is priced into markets.
One reason is that labour markets have continued to tighten, and wage pressures, though still very moderate given the low level of unemployment, have been picking up recently. If unemployment falls further as economic growth recovers this year, wage pressures are likely to intensify over time, and firms will find it easier to pass on cost increases as demand improves.
Also, with fiscal policy likely to become more expansionary over time, in line with our view that “fiscal is the new monetary,” nominal demand should be better supported, especially if central banks play ball and don’t aim to offset fiscal easing with monetary tightening as the Fed did in 2018.
Last but not least, after many years of missing their inflation targets on the downside, virtually all major central banks seem to prefer inflation (the devil they know) over deflation (the devil they don’t know). While any changes resulting from the Fed’s ongoing and the ECB’s upcoming strategic review are likely to be evolutionary rather than revolutionary, we expect a nod toward average inflation targeting in the U.S., and a more symmetric 2% inflation target or target band centred around 2% in the euro area, implying a higher tolerance by two major central banks for potential inflation overshoots.
Against this backdrop, and despite the expected global growth recovery this year, we see the major central banks largely on hold this year and expect the bar for tighter policy to be generally higher than the bar for further easing. While discomfort with negative interest rates in Europe is rising given the unpleasant side effects, the ECB is very unlikely to exit until well beyond our cyclical horizon.
Expect curve steepening in the U.S. and in other countries, reflecting valuations but also reflecting the combination of front ends anchored by central banks – that will be reluctant to tighten policy – and the potential for higher inflation expectations to be priced in further out the curve. Curve steepening positions should also provide our portfolios with some cushion given the rise in U.S. government deficit and debt and the possibility that, over time, markets will demand more term premium in the event of further deterioration in the fiscal outlook. U.S. Treasury Inflation-Protected Securities (TIPS) look attractive on a valuation basis and, given the high bar for the Fed to hike rates, even in a somewhat stronger environment. While the outlook for inflation is subdued, the balance of risks is toward a higher inflation outlook than the relatively depressed level priced into TIPS break-evens.
While most have an economic outlook of a moderate pickup in global growth amid supportive monetary and fiscal policy is relatively benign, we remain cognizant of the potential for significant bouts of volatility caused by geopolitics and national politics around the world.
While a limited Phase 1 trade deal between China and the U.S. is in the making, relations between the established power U.S. and the rising power China remain fragile and tensions could easily erupt again during this year.
Another area of focus this year will be the U.S. elections in November. Risk markets will pay close attention as the field of Democratic candidates for the presidency narrows during the primaries.
Moreover, the recent wave of protests against the political establishment across many emerging market economies may spread further, especially as potential growth in many of these economies has downshifted, which increases the dissatisfaction with governments and sharpens the focus on income and wealth inequality.
While the baseline outlook for 2020 looks positive, we also recognize risk premia has been compressed by central bank action, leaving little cushion in the event of disruption. We see a range of political and geopolitical risks in addition to the potential for macro surprises, central bank exhaustion, and rising volatility. As well as a close focus on liquidity management, careful scaling of investment positions, and caution on generic credit, we will look to have somewhat lower weight on top-down macro trades, to keep powder dry and potentially go on the offensive in a more difficult investment environment.
- Recession risks have diminished, and we are more confident in our baseline forecast of a moderate recovery in global growth this year.
- But monetary policymakers now have even less space left to guard against future recessions.
- Thus, while “time to recession” has likely increased with last year’s monetary easing, so has “loss given recession.”
- Considering the outlook, we seek to invest with a bias to higher-quality positions, a very close focus on portfolio liquidity, and a diversified approach to generating income.
A view on asset allocation is often rooted in an assessment of where we are in the cycle. Early in the cycle, valuations are cheap, policy accommodative and the economy has ample spare capacity to grow. It’s often a good time to take risk.
Conversely, late cycle is usually a good time to take chips off the table. When the economy is displaying signs of exuberance or overheating, higher interest rates usually put an end to the party.
It’s proving much harder to navigate markets today based on an assessment of the cycle. The map is far from clear. Unemployment rates – often a key navigation tool – are near record lows in most parts of the developed world, suggesting the economy is very late cycle. However, there are very few other signs of classic late-cycle economic exuberance. Neither business nor consumer spending looks toppy. Indeed, the US consumer is looking remarkably prudent: the savings rate, which often falls sharply late in the cycle, is pretty high. And inflation is certainly not suggesting the global economy has reached its limits. In fact, central banks are preoccupied with the idea that inflation remains too low and may be getting stuck. Rather than trying to tame the expansion, the primary focus for central banks is how to gee it up.
This makes it very hard to say confidently how much time is left on the economic clock.
A resolution in the US-China trade conflict, a Brexit solution, and an easing of tensions in Hong Kong, Chile and Turkey could fuel a turnaround in business sentiment and a reacceleration in activity in 2020. Against a backdrop of muted inflation, interest rates could stay low. This would be a good environment for risk assets.
But it is more likely, in our view, that geopolitical risk will linger. We think the trade conflict is unlikely to be fully resolved. Surveys suggest the US electorate believes the president is right to address unfair trade practices, while on certain areas of the disagreement – such as China’s state-led subsidies for its tech sector – there is seemingly no common ground. China believes in industrial policy, the US does not.
The US administration does seem to appreciate that it needs to get the balance right between keeping the agenda alive and not damaging the US expansion, hence the recent more conciliatory tones. We’ll see in the coming months whether this more measured approach does much to boost corporate sentiment. Companies have been spooked, and are likely to remain reluctant to invest, which will limit the extent to which manufacturing bounces back through the course of 2020. This reluctance appears to be filtering into hiring intentions.
While equity investors have earned 20% year-to-date, most of these gains occurred by April 30, as markets rebounded from the sharp declines of fourth quarter 2018. From September 30, 2018, through October 31, 2019, global equities have returned just 5%. Equity valuations remain close to last year’s levels, as equity appreciation has paced 4.7% global earnings growth. At the same time, ten-year G4 sovereign bond yields have fallen significantly, credit spreads have tightened, and lending standards have deteriorated.
Diversification remains central in 2020. Even with near-zero yields, sovereign bonds can prove useful in a market downturn, and we favour them over liquid credits. Within liquid credit, we prefer structured credit and trading-oriented distressed strategies that could capitalize on market volatility.
Investors should rebalance US equities and growth stocks, which have outperformed during this market expansion, to at least a neutral allocation. Should the expansion continue, the overvalued US dollar may soften amid relatively loose monetary policy conditions in the US, boosting non-US equities. Further, softening growth in China, Germany, and Japan have dragged down US growth. These countries are further ahead in the economic cycle than the US and may stabilize before it does, providing the catalyst needed for global ex US equities to outperform. Improved macro conditions would also support value stocks over growth stocks, where relative valuations have become extremely stretched. Select private investment strategies remain appealing. Secondary funds and direct transactions offer distinct advantages at this stage of the cycle, given their discounted pricing and more immediate return of capital.
Finally, as we enter 2020, investors should consider what trends may be most consequential over the next decade. Slower economic growth, deteriorating developed markets demographics, and low productivity growth lift the appeal of less economically sensitive investments often found in private credit opportunities. Investors should boost their portfolios’ resilience to climate change and social inequality challenges through private investments in areas such as climate change mitigation and adaptation solutions, education and workforce development, affordable housing, and financial inclusion. Private real assets also offer opportunities to benefit from secular trends, most notably urbanization, changing demographics, and technological innovation.
Geopolitical tensions and central bank easing will be the key factors to look out for as gold continues to trend above last year’s peak of $1,553, the highest level since 2013. both the threat of a military conflict with Iran and trade disputes with China are likely to remain powerful drivers for the remainder of the year.
The former had spiked gold to a seven-year high of over $1,600 a mere week into 2020, while the latter acted as a consistent source of support throughout last year.
Besides geopolitical tensions, loose central bank policies should keep pushing gold prices up just as they had for the better part of 2019. The Fed could not only slice interest rates to zero to combat a possible recession, but also allow for a period of high-running inflation, both of which would act as major sources of gold’s gains. Uncertainty will continue dominating investor sentiment and keep driving the heavy safe-haven buying seen as of late. Besides tensions with the Middle East, the analysts cited the coming U.S. presidential elections as another potential source of high volatility. Furthermore, the team expects central banks to continue supporting gold prices on a grand scale, both through accommodative policies in the midst of weak global growth and through their all-time high bullion purchases.
With so many tailwind, analysts forecast an average of $1,636 this year and expect the metal to climb as high as $1,780.
Regarding other metals, analysts think that silver will continue trailing gold as it moves up, citing strong fundamentals and the correlation with gold as the reasons why silver will push to $21 and average $18.50 this year.
Summary
- Global economic growth stabilising in 2020
- Recession fears receding slightly, but remain high relative to recent years
- Generally slower growth environment increases the risk of social tensions
- Chinese policymakers face increasing domestic & foreign constraints
- US partisan divisions to get worse, before they get better
- Beware the China Virus
- Buy gold
