Investment Outlook 2020 Late cycle rebound

We are at a late cycle inflection point. But late cycle does not mean end cycle. Are short-term recession fears overdone?

02 Dec 2019

Rather, we expect a moderate growth reacceleration in early 2020 as geopolitical risks abate, China's growth slowdown stabilizes and as the lagged impact of looser monetary policy globally feeds through to demand. Lower USD borrowing costs also herald an important easing of financial conditions to emerging markets that is likely to be positive for global demand growth.

Investment outlook 2020 – global manufacturing indicators turning

The global demand slowdown in 2019 has been largely driven by global industrial production and trade as the negative impacts of the US/China trade dispute have increased.

But global manufacturing lead indicators are now turning and we expect these tentative signs of improvement to become more definitive in the coming months.

Lead indicators suggest global manufacturing growth is rebounding

Source: UBS Asset Management, Refinitv, as of November 2019.

Easing of financial conditions key

Key to the moderate demand pickup we expect is the delayed boost to economic activity from the significant easing of global financial conditions.

Over the past year, the US Federal Reserve has performed a sharp policy pivot from the tighter stance and rhetoric of late 2018 to its current more accommodative position. Recent statements support our view that the Fed is now more likely to let US growth and inflation 'run hot' than it is to tighten policy early and risk a sharp downturn.

We do not see the US Federal Funds rate rising in the near term. Importantly, the shift to looser policy has not taken place only in the US, but has been broad based across both developed and emerging markets.

Absent any extraneous demand shock, we see this supporting growth throughout the early part of 2020 as the boost from lower rates feeds through more powerfully to manufacturing. We also expect consumption growth to remain resilient in 2020, underpinned by low unemployment and solid wage growth. Should growth falter, we believe that calls for fiscal stimulus to play a greater role in the overall policy mix will grow louder in a number of major economies.

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China's policy stance

Despite GDP at its lowest level since 1992, the one major central bank whose policy stance has not moved to unequivocally loose is the People's Bank of China (PBoC).

The five basis point cut in one-year bank lending rates in early November is evidence that the PBoC is not ignoring the growth slowdown. But its modest nature perfectly reflects the difficult balancing act it faces between conflicting cyclical and structural goals. This does not concern us unduly.

With the full monetary and fiscal policy toolkit at their disposal the Chinese authorities are able to turn to other measures alongside interest rates to influence the rate of demand while rebalancing its drivers.

We expect Chinese growth to stabilize as these policy actions take effect and there is scope for further stimulus measures if necessary.

Geopolitics a risk and opportunity

Geopolitics represent both risk and opportunity. Brexit and the US/China trade standoff were the headline geopolitical stories of 2019. However, the probability of a worst case scenario on both issues has clearly diminished. We see sufficient goodwill in the most recent US/China rhetoric to suggest that some of the previously announced tariffs could be cancelled rather than just postponed. Such an outturn could provide much needed support to global corporate confidence.

Short-term recession concerns overdone

Twelve months ago we said that global growth fears were overdone given the likely resilience of developed world labor markets. We therefore entered 2019 with a positive view on global equities that has since been well rewarded.

We continue to see short-term recession concerns as exaggerated and there are major opportunities from a tactical asset allocation perspective in an extension of the business cycle and a stabilization of growth prospects relative to what is priced into markets. We expect some sharp rotation within risk assets.

Investment outlook 2020 - Favour growth sensitive equity markets

Given our belief in a modest demand rebound, we currently favor the more growth sensitive equity markets of the eurozone, China, Japan and emerging markets. US equities have enjoyed a sustained period of outperformance in a global context. We understand the tactical argument that the more domestically focused US indices are less exposed to near term trade war concerns. However, as 2020 progresses we see a mix of both cyclical and structural factors coming into play. In particular headlines around the US presidential election and potentially dramatic changes in US economic policy will likely prompt bouts of volatility that may disadvantage US equities over their international peers. Still, investors must weigh the probabilities of one candidate having the full legislative backing to generate truly transformational change.

Strong argument for China / EM equities

There is scope for Chinese equities to rerate higher as capital markets open up to international investors and we see capital flows increasing in the wake of the inclusion of onshore Chinese equities in MSCI's widely followed emerging market (EM) equity indices. There are also strong arguments for wider EM equities, which we see as the major beneficiary of a global demand bounce, any US/China trade truce and of the cut in USD borrowing costs.

Yield curves steepening

A modest rebound in global demand suggests to us that there will be at least some upward pressure on longer-dated government bond yields given the very low growth and inflation assumptions reflected in the 10yr government bond prices of developed countries including Japan, Germany and Switzerland. With monetary policy likely to remain loose even in the face of improving data, we see developed world nominal yield curves steepening.

Chinese bonds stand out

Our favored market for this view is the US, where we are long the UST two year and short the UST 10 year in a yield curve 'steepener' to exploit this scenario. Given relatively high nominal and real yields Chinese bonds stand out to us as the one genuinely attractive major sovereign bond market. Inclusion in major bond indices is likely to see additional structural downward pressure on Chinese yields.

Credit also offers some compelling opportunities to play a cyclical uptick. As with EM equities, we see a rebound in global manufacturing and lower USD funding costs as being supportive for emerging market credit in general. Against this backdrop, both local and hard currency EM yield spreads over US Treasuries appear attractive vs. US investment grade and US high yield.

Staying flexible and nimble to exploit asset allocation opportunities in 2020 and beyond

The maturity of the cycle, residual geopolitical risks and some crowded positions across asset classes raise the prospect of intermittent bouts of headline and intra-market volatility in 2020. In a lower growth environment, returns from risk assets are also likely to be lower than investors have enjoyed for most of the last decade. Given this backdrop, we believe that staying flexible and nimble to exploit asset allocation opportunities as and when they arise will be important in 2020 and beyond.

What surprises await investors in 2020?

How can you prepare your portfolios if unexpected events happen in 2020?

Evan Brown

Head of Multi-Asset Strategy

Evan drives macro research and tactical asset allocation investment process across asset classes. Additionally, he drives thought leadership to clients through advisory mandates and investment publications.

Prior to joining Investment Solutions, Evan was a strategist and trader for macro hedge fund portfolios at UBS O'Connor and Millennium.

Previously, Evan co-ran US FX Strategy at Morgan Stanley, where he ranked 2nd in the All-Americas Institutional Investor poll for Currencies/Foreign Exchange.

Evan worked on the New York Fed's Open Markets Desk from 2006 to 2009, where he briefed senior policymakers on financial market developments and helped build policy responses during the Great Financial Crisis.

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