By Chris Iggo , CIO Core Investments
For the past two years, investors have feared that the global economic slowdown could eventually turn into a typical end-of-cycle recession. However, recent months have witnessed these anxieties fade.
Monetary policy, together with an easing in global economic uncertainty, could even potentially extend this already prolonged cycle beyond the scope of this current outlook.
As such, we do not believe that there will be a bear market in risk assets in the next 12 months. However, our optimism is tempered, and it will be hard to match 2019’s returns in either bond or equity markets.
Valuations are rich in many areas – bond yields are already lower than they were at the start of 2019, while equity ratings are higher. Additionally, if there are risks to the macro outlook, they are biased to the downside – even if sentiment is potentially boosted by positive developments on issues such as trade and Brexit.
Monetary policy: Likely to stay on hold
What we can have some confidence in is that the interest rate environment is not likely to change much. The pivot from tightening to easing by the Fed at the end of 2018 paved the way for more rate cuts in 2019 while for its part, the ECB delivered further easing in September.
For now, there appear to be few reasons for additional loosening and the modest pick-up in bond yields in the fourth quarter seems to suggest that markets are not looking for it.
Indeed, to achieve the same level of return in the coming year as those achieved in 2019, yields would have to fall a lot further – in many cases to new lows. And only if the economic situation deteriorates significantly would we likely see such an occurrence. Perhaps what is more probable at this stage is somewhat better news on the macro side and modestly higher yields.
Bonds: Watch out for volatility
Looking ahead, we don’t see significant directional moves in fixed income – not when monetary policy is anchoring interest rates at such extremely low levels. Global capital flows are also important. Should US Treasury yields rise to the 2.0% to 2.5% range, investors from Europe and Japan are likely to become buyers, given the low yields on offer in their domestic markets. On the credit side, despite the economic cycle being somewhat long in the tooth, there are few signs of a significant deterioration in the credit cycle.
Low interest rates help – and so does the broader monetary policy environment. Our high-yield teams expect default rates to remain low. A bias towards corporate assets in the bond market might continue to be rewarding. In Europe, the fact that the ECB has re-started buying corporate bonds is also a strong support for credit spreads remaining relatively tight.
A significant bond bear market would require a more dramatic inflexion point in the economic outlook. I am sure that most readers don’t attach too much probability to the Fed hiking rates again any time soon, or for inflation to surprise on the upside.
Nor is there much chance of European governments going on a spending splurge – except perhaps in the UK given the promises made during the general election campaign. Europe needs more expansionary fiscal policy and more supply of highly rated government bonds but that is not going to happen quickly.
Nevertheless, we should not rule out possible bouts of bond market volatility. Given the low-yield environment, we favour strategies that limit volatility, focus on income returns and/or are diversified and flexible enough to generate steady returns through active allocation to the parts of the market offering the most value.
For the former, short-duration strategies have a strong track record of limited downside participation in bear markets, while matching a good part of the upside when markets perform well. This is especially the case in the higher beta parts of the market like high yield and emerging market debt. In our view, these strategies seem well suited to the current market outlook.
Equities: Dominating the yield hunt?
Right now, our multi-asset team’s stance is to be more optimistic on equities from a cyclical point of view. Supportive policy and some hope of resolution on the trade war and Brexit should underpin positive sentiment in equity markets. Where there is scope for some upward revision to growth, e.g. Germany and China in an improved global manufacturing scenario, or the UK post a soft-Brexit deal, we could see an improvement in relative equity market performance.
Growth should re-assert its dominance over value in a modest economic growth scenario with low interest rates. Cyclicals are still very cheap relative to bond-like defensives and some further valuation adjustment could take place. While it is less obvious in the US, many equity markets and sectors have a dividend yield that is superior to those offered by bonds.
Income investors are likely to continue to find more rewarding opportunities in the stock market than in fixed income, especially in Europe where much of the bond market is in negative-yield territory. However, exposure to a global inflation risk-premium through inflation-linked bonds and to higher bond income through European high-yield is a useful complement to our tilt towards equity markets. Our multi-asset team believes that this environment is suitable to their outcome-oriented solutions i.e. growth, income, impact and purchasing power maintenance.
Active ESG: The only way ahead?
Looking ahead to 2020 and beyond, I expect two themes in particular will continue to dominate investor debate - passive and active investing, and the greater need to account for environmental, social and governance (ESG) considerations in investment decisions. At AXA Investment Managers, we characterise ourselves as active, long-term, and responsible investors. While getting access to market beta via a passive approach has its merits, we see the argument as being much more nuanced than simply one style being better than the other.
Our view of what constitutes active management is not simply about outperforming an index. It is about providing solutions to investors by addressing their return objectives, whatever they might be. Active management is about providing investors with choice and flexibility. A short duration strategy in fixed income might not be ‘active’ in the sense that there is a lot of rotation between sectors and parts of the curve, but it represents an ‘active’ choice as it targets a specific return profile.
Similarly, the provision of thematic investment choices is an ‘active’ choice, built on our view of how we see the global economy evolving over the long term on the back of major demographic and technological advancement and change.
Today active also means implementing ESG factors into investment decisions – which a passive approach cannot do. Investors want their capital to be invested in companies that can contribute to the alleviation of climate problems, social injustices and questionable business practices. We firmly believe that this approach will not only help make the world better but potentially reward investors with superior performance over the long run.
As an active investor we devote substantial resources to researching and assessing ESG factors in the same way we assess business models, margins and credit risk. Active management means striving to find the best risk-adjusted returns. But an increasingly vital part of this process is identifying risks and the long-term sustainability of our investment strategies.
Read our full 2020 Outlook here.
Not for Retail distribution: This document is intended exclusively for Professional, Institutional, Qualified or Wholesale Clients / Investors only, as defined by applicable local laws and regulation. Circulation must be restricted accordingly.
This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.
Due to its simplification, this document is partial and opinions, estimates and forecasts herein are subjective and subject to change without notice. There is no guarantee forecasts made will come to pass. Data, figures, declarations, analysis, predictions and other information in this document is provided based on our state of knowledge at the time of creation of this document. Whilst every care is taken, no representation or warranty (including liability towards third parties), express or implied, is made as to the accuracy, reliability or completeness of the information contained herein. Reliance upon information in this material is at the sole discretion of the recipient. This material does not contain sufficient information to support an investment decision.
Issued in the UK by AXA Investment Managers UK Limited, which is authorised and regulated by the Financial Conduct Authority in the UK. Registered in England and Wales No: 01431068. Registered Office: 7 Newgate Street, London EC1A 7NX.
In other jurisdictions, this document is issued by AXA Investment Managers SA’s affiliates in those countries.
