In 2019 financial markets posted a record year in terms of performance across all asset classes. This caught many investors off guard given the on-going deterioration of macro data, worldwide negative earnings revisions and plenty of (geo)political risk. Fortunately, central banks have stepped in to support stumbling financial markets ever since the global financial crisis (e.g. QE1-3, Operation twist, Powell pivot, etc.). We have stepped into a brave new world. Both the micro-and macro-economic backdrop as well as the central banks’ policy, will continue to be key factors to consider in any future asset-allocation decisions. The FED’s monetary-policy U-turn has led to an important pivot of global financial markets in early 2019. Central banks across the world quickly followed suit. The eagerly-anticipated ECB meeting in September proved to be a game changer. It announced a tiering system for banks, the TLTRO3 and the activation of an open-ended CSSP2 program. As a result, interest rates recovered slightly, yield curves steepened across the continent, and value stocks came in vogue again after years of underperformance. The widespread belief that trillions of negatively-yielding bonds had become “the new normal’ suddenly faded.
Those who focused too much on weak macro data and negative earnings revisions missed out on performance. Investors who missed the train in 2019 will probably be inclined to jump on the wagon at the beginning of the new year. Why? There is a veritable wall of cash out there that needs to be invested. Moreover, since December 2019 investors feel encouraged by the slightly more positive evolution of confidence indicators, the positive -albeit modest- economic growth outlook in 2020, the low interest-rate environment and the dovish stance of the central banks. These positive indicators further strengthen our belief that earnings could start to bottom out in 2020. The market recovery will nonetheless be choppy.
The markets are bound to be rather turbulent due to lengthy Brexit negotiations (Boris Johnson is not expected to come to an agreement before the end of the year) and a disappointing “phase one” deal between the US and China. A lasting truce in the trade war which started in 2018 is not yet in sight. At least this temporary agreement offers some respite to financial markets. After their outstanding performances in 2019, we expect financial markets to keep up their positive momentum -at least for the first quarter of 2020-. However, from the second quarter on, we could witness a surge in volatility brought on by the preliminary US-elections. Still, equities remain our investment class of choice in the medium term. Although she’s 80 years old, TINA (Turner) is still alive and kicking ! All in all, we are looking at mid to high single-digit returns this year.
Within a balanced portfolio, it is advised to counterbalance the extra equity risk with a more defensive positioning on the fixed income side. As 2020 might be a transitional year for European sovereign bonds, we favour international bond exposure with positive carry, such as US Treasuries, Euro peripherals and Emerging market debt. Inflation-linked bonds are still cheap and provide an interesting hedge to prevent any sudden upward-inflation surprises We are very selective in corporate bonds as credit spreads worldwide are trading at historic lows. Our base-case scenario of higher interest rates and steeper curves validates our short-duration stance.
Within equities, we have a structural preference for US equities because of the solid US economic backdrop, the supportive market structure and the strong labour market that feeds into consumer confidence. This, in turn, supports the economy and the financial markets. Furthermore, there is a high probability that US markets will post positive returns because of the upcoming election. Because of the strong multiple expansion we witnessed in US markets in 2019, we have trimmed our overweight position to neutral. For multiples to remain elevated, top line and earnings growth will have to follow suit. At the end of last year we became more positive on European equities for a couple of reasons. First, the valuation gap between Europe and the US is approaching extreme levels. Second, political risks in Europe are receding. A no-deal Brexit – which could lead to a European recession – has been avoided. Third, it seems that trade war risks have eased. This should boost business confidence indicators worldwide, which could consequently lead to a revival in Capex investments. Nevertheless, a sudden resurgence of trade tensions between the US and Europe could still throw a spanner in the works.
European interest rates started to normalize in the wake of the September ECB meeting. This caused a style rotation from growth to value stocks in the fourth quarter of 2019. Banks have been the biggest beneficiaries of this move. We stick to our barbell approach, which pushes us to dynamically alter our positioning in growth versus value stocks, or cyclical versus defensive sectors. We currently have a preference for value and cyclical stocks given the prospect of higher interest rates, steepening yield curves and the low volatility environment. Although their performance was lacklustre in 2019, we think 2020 could be a strong year for emerging market equities. China’s growth could stabilize on the back of the PBOC’s dovish stance, the stabilization in world trade, and a potentially weaker USD as trade war risks recede.
Another element which could provide an extra boost to the European markets would be the decision by the European Commission and the EU member states to push through a fiscal stimulus package. Politically, this is still a hotly contested matter for now. Still, if the European economy suddenly deteriorates, this stimulus package could gain a lot more traction. The news of such a deal would significantly reinvigorate the markets, even though its actual effects would likely take up over 18-24 months to materialise. Empirical evidence from Japan proves that the multiplier effect of fiscal stimuli is far greater in a low rate environment.
Geopolitical risks will always be around. As such, they are not a determining factor in allocation decisions. In the past, geopolitical events have proven to create the best entry points for risk assets. Recently, the US-Iran standoff has clearly showcased the market’s complacency. Its impact barely lasted a couple of days, but still allowed for great buying opportunity as stocks temporarily traded at bargain prices. This also demonstrates the eagerness of investors to step into the markets at any sign of weakness (buy-the-dip mentality). If nothing else, it comforts us in our conviction that the equity bull market has not run out of steam quite yet.
