08 Jan 2020
It seems like the secular disinflationary forces of the 3 Ds; Disruption in terms of technological advances, the high levels of Debt, and negative Demographics, are here to stay. If monetary policy is fully played out, there is a question whether structural disinflationary forces will turn into something more sinister, described as secular stagnation by Lawrence Summers.
The IMF have noted that, whilst two years ago growth was accelerating in 75% of the world, it is expected to decelerate in 90% of the global economy in 2019. Summers argues that, despite loose monetary policy and looser fiscal policy, central banks continue to fall well short of their inflation targets due to a demand deficit. To respond to this, governments globally need to increase the level of fiscal support for their economies, whilst trying to avoid self-inflicted wounds by cooling the anti-trade deficit and solving Brexit issues. In the UK, the Conservatives are calling for an end to austerity and promising a significant fiscal boost to the economy. 2019 feels like a year when the world has moved from slow growth to slower growth, with a lack of animal spirits by corporates due to the uncertain macro backdrop, not helping the global economy after a long period of expansion. Geopolitical concerns outside trade and Brexit such as the Middle East and Iran, are also a concern.
Looking within broad market indices in the current economic environment, it is unsurprising that growth orientated strategies have outperformed value. Whilst valuation differentials have moved to what some describe as extremes, a low growth world with muted inflation and tight investment grade bond spreads, favours industries such as utilities and consumer staples that are able to show some growth, irrespective of the economic background. This year it is not just cyclical low-quality equities that have lagged the market rally, but performance of lowly rated CCC (high yield or junk) bonds has also been poor. A significant rotation into cyclical assets is unlikely to occur until macro conditions improve and/or policy concerns fade and inflation shows some signs of picking up. The performance of government bond markets in 2019 has favoured quality orientated growth strategies, together with assets offering visible and sustainable earnings and as yet there seems no real catalyst for higher risk assets to outperform. As well as growth orientated strategies, global listed infrastructure has been another strong performer in 2019.
With approximately $15 trillion of government bonds giving negative returns, ultra-low risk assets remain an unexciting home for investor money. However, government bonds still provide some degree of diversification in periods of turbulence and weak equity markets and with today’s low rates looking likely to stay lower for longer, there remains potential for credit spreads to tighten further, especially in investment grade.
As long as recession is averted and corporate earnings can show some recovery in 2020, equities still look likely to deliver positive returns and better returns than other asset classes. Although, after a long bull market, investor nerves are always jittery and when market setbacks do occur, they are likely to be sharp and sudden as we have seen in 2019. Internal market dynamics with an increased number of trend-following strategies can also heighten levels of market volatility if negative news emerges and this tends to exaggerate short term market trends.
While alternatives always seem a potentially interesting home for investors in the sort of macro conditions pertaining today, the cash element of cash plus strategies has fallen further in 2019 and in the Eurozone is now significantly negative at -50bp. Within alternatives, careful selection of strategies is important as any one blow up can be hard to recover from if it occurs within a portfolio.
Equities are still one of the better homes for medium term investors, although keeping some fire power available for a market setback after the strength of markets year to date would seem prudent. For investors wanting lower risk equity options, global listed infrastructure assets continue to look attractive as a core part of a portfolio. UK assets have potential to bounce if a satisfactory conclusion to Brexit is achieved. Within the emerging world, Asia remains less cyclical than Latin America and the stimulus measures implemented in China have favoured domestic consumption, which looks likely to remain reasonably strong. Overall a portfolio of higher quality equities with defensive characteristics still have potential to deliver positive returns over the next few years.
Graham O'Neill, Senior Investment Consultant, RSMR
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