Head of Concentrated Alpha Equity and Lead Portfolio Manager
How much longer do you expect the US equity bull market to last?
Predicting recessions is notoriously difficult. However, we see no obvious short-term catalyst that will derail the US equity bull market. The medium-term outlook is dependent on the US/China trade war, economic growth and interest rates. Typically, a build-up of economic imbalances or overly tight monetary policy bring cycles to an end. But both factors are weak this time around: corporates and consumers are relatively cautious and central banks are leaning towards dovish policies.
Where should investors be positioning themselves for surprises such as a trade war truce, and what areas of the market look like good opportunities?
Investors are faced with a number of market risks. The most obvious one stems from the US/China trade war, where a short-term ceasefire seems likely but major improvements less likely due to ideological differences and China's political ambitions. We expect slower Chinese growth as the shift from exports to internal consumption continues. UK corporate investments have already slowed ahead of Brexit, creating pent-up demand. However, recovery potential is likely limited as consumers have not been overly cautious. Asset prices could be boosted in the run up to the 2020 US presidential election given Trump's preoccupation with equity market returns. Central banks are expected to remain supportive and short-term interest rates will likely continue falling, supporting equity valuations. We expect downgrades to 2019 earnings and believe current 2020 EPS estimates look ambitious. As stock pickers, we focus on companies where the earnings growth potential is driven by company-specific factors or secular growth, rather than being reliant on cyclical factors that are out of the company's control.
Head of Fixed Income UK, Senior Portfolio Manager
The third quarter of 2019 saw an inverted US yield curve. What does this mean for investors in the coming months?
Bond yields did indeed collapse across the globe in 2019 as fears about trade and a slowdown in China gathered pace. But there are also structural factors at work suppressing longer dated bond yields, meaning investors are probably reading too much into the shape of the US yield curve today. We need to consider the extent to which yields have been lowered by central bank action since 2008. Remember it was an explicit goal of the US Federal Reserve, as part of its quantitative easing (QE) program, to flatten the curve and crowd out investors from government bonds and into more productive areas of the economy. Add to that the strong demand from yield hungry investors from Japan and the Eurozone and you end up with a very flat US curve that, in our view, signals less about the probability of recession and a lot more about the side-effects of QE.
Where should investors be positioning themselves?
Bond investors have become very downbeat about the outlook for growth and inflation in the Eurozone and this is reflected in negative yields in several countries, most importantly Germany. In many ways this is justified given the structural challenges faced by the region, the ECB's recent expansion of QE and unstable US-China relations. However, any improvement in the near term outlook, particularly around a trade deal, would leave Eurozone bonds looking very poor value indeed and subject to a material repricing. Instead the US and China, where real yields are higher, currently offer better opportunities for investors and a more attractive risk/reward trade off.
Chief Investment Officer, O'Connor
Can value outperform growth in 2020?
Although the low rate, low growth macro environment seems set to continue in 2020, recent market performance shows us that this is a consensus view and that the resulting investor positioning in short value and long growth and momentum factors is extreme. While any headline indicating resolution of one of the many macro risks weighing on the market is likely to create squeezes in value and underperformance of growth, we do not expect value to outperform growth in 2020. Slowing economic growth and the reality of how late we are in the economic cycle present a significant headwind for value that will likely be difficult to overcome. Additionally, growth and momentum stocks are typically characterized by differentiated business models and management teams, both of which can drive sustained outperformance over a long cycle.
How should investors position themselves for market surprises, such as Brexit or US election results?
Our experience has been that in a market environment beset by significant event risk, investors are well served by carrying lower amounts of baseline risk while looking to be dynamic, seeking to exploit the inevitable dislocations that arise from the combination of highly consensual investor outlooks and residual event risk. In such an environment, investors should pay particular attention to segments of their portfolio where crowding is prevalent. Such positions are often vulnerable to spontaneous de-risking and sharp reversals when events or newsflow challenge the consensus view.
While the market can often ignore economic data and corporate fundamentals for short periods of time, it will eventually return to these fundamental drivers. Therefore, it is important to focus on our core investment principles while maintaining a healthy respect for the ability of positioning and sentiment to be the primary drivers of performance for extended periods of time.
Lead Real Estate Strategist
What changes do you expect to see in real assets in the year ahead?
The shift in monetary policy is expected to have a profound effect on real estate in 2020. Real estate risk premia, reflected in the property yield premium over risk-free rates, have gone from equal to or below long-run averages to on par with or above those averages. Although total returns have deteriorated from their highs in 2015-2016, the level of return is, in our view, still attractive. We believe the sector will continue to attract capital. However this will need to be balanced against a weakening economic outlook, which will likely impact tenant demand and therefore rental growth. We foresee limited capital value growth and returns driven almost exclusively by income.
What areas of the market look like good opportunities?
In 2020, we believe that investors should focus on embedded value-creation and/or property sub-sectors where demand exceeds availability. Such areas include last mile logistics, student housing, research and development facilities, aged care and multifamily, depending on the market. That said, these are also where the greatest competition exists.
Given we do expect only limited capital growth, we also believe this is a market where asset management skills are likely to prove pivotal to returns. In particular, the skill to identify buildings which can be upgraded, reconfigured, re-tenanted, or re-positioned to generate new revenue streams or to enhance rental income can make a material difference. Investors also need to ensure that there is actual demand for that type of asset, particularly as economic growth slows. We also advocate carefully limiting costly portfolio turnover. Finally, it will also be important to avoid simply getting into a competition for yield or pushing up leverage to generate returns.
Head of Portfolio Management, Investment Solutions
How can a multi-asset approach help smooth returns over the next year?
Since the chastening experiences of the global financial crisis of 2008/2009, investors have become more aware of the potential for sharp and disproportionately large drawdowns from single asset classes. Given enough time, many of these drawdowns will be reversed, but staying fully invested in order to capture the rebound assumes that investors don't have liquidity needs in the interim. Overall we believe that these types of risk are inherent within financial markets, but that investors are rewarded with returns over time by taking on these types of temporal risks.
Where should investors be positioning themselves?
We believe the strategic asset allocation (SAA) decision is the single most important decision that any investor can make. At UBS Asset Management, we develop and update quarterly our five-, 10- and 30-year return expectations for a variety of assets. Read our most recent capital market return expectations here.
SAA relies on historical or modelled relationships which we believe should have a high probability of holding over the medium and long term, but that are more prone to surprises over the short term. The challenge to this approach at the moment is there are few asset classes that are notably cheap. In fact, some asset classes that normally play an important defensive and diversification role are notably expensive. Investors are therefore rightly worried about downside risk from a variety of market attributes.
Understanding near-term risks lends itself to a strategy that tries to be more nimble in allocations. We believe that valuation is the most important driver of asset class return over the long term but we also recognize that it has almost no effect on asset returns over the short term. For this reason, an active tactical asset allocation that takes macroeconomic themes and the positioning of other investors into account may benefit returns and risk management over short horizons.