Multi-Asset Investments views – January 2020 – Our investment views for 2020
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Our key convictions :
- We continue to overweight equities as positive developments (Central banks easing, Trade war, Brexit) release some pressures and should allow global growth to navigate a soft landing in 2020
- We maintain a cyclical tilt in our equity exposure as macro data suggests the manufacturing cycle has bottomed out
- We remain positive on Euro High Yield as a dovish Fed, ECB and BOJ are supportive of carry positions
- We remain constructive on Eurozone and US inflation breakevens as market pricing remains too pessimistic
- Overweight equities
- Cyclical tilt in our equity exposure (including call option on banks)
- Positive Euro High Yield
- Positive US and Eurozone inflation breakeven
- Long equity call options delta hedged to protect the portfolios where possible
Our views for 2020
We added more risk in our portfolios last October. Looking into 2020, we believe that the positive drivers will continue, at least for the first half of the year.
At AXA Investment Managers, and within the multi asset team in particular, we look at markets through the lens of four factors; namely macroeconomic (M), valuation (V), sentiment (S) and technical (T) which we think drive asset returns. Macroeconomic analysis is used to identify the current stage and future direction of the economic cycle as different assets are expected to perform differently in each phase (expansion, slowdown, recession or recovery). Valuation refers to the current prices of assets relative to their ‘fair’ valuation. When current prices are deemed to be rich, they are expected to fall and when prices are deemed to be cheap, they are expected to rise. Sentiment refers to investors’ overall attitude toward an asset and it is not usually based on fundamentals but on behavioural forces like fear and greed which affect investors positioning and thus impact the prices of assets. Technical factors focus on the study of price, supply and demand trends and can be helpful in identifying entry and exit points. What are the conclusions for 2020 of our MVST factors analysis ?
First, on the Macroeconomic side, heading into 2020, our leading indicators show signs of improvement, pointing towards a stabilization in growth momentum rather than a continued deceleration as was the case in recent quarters. Strong job gains and unemployment at 50-year lows, coupled with still-elevated consumer confidence and a rebound in financial conditions point to a good momentum for consumers. We therefore believe that a US recession is unlikely over the next quarters. We also think that the manufacturing activity downturn witnessed over the past 18 months is likely to end, partly helped by the positive impact from recent Fed cuts which is likely to filter into the economy in the first half of 2020. It will also benefit from the trade truce between the US and China and particularly from the partial roll-back of tariffs. In this context, we expect companies’ earnings to grow by 5% globally and credit spreads to remain well behaved. They usually start to widen 18-months ahead of the next downturn. Inflation at or below target in 2020 should keep central banks on hold through 2020.
Valuation-wise, equity multiples remain undemanding versus history, and even more so versus other asset classes. In absolute terms, it is true that equity valuation multiples have rerated by more than 20% from the low in Q4 2018 when markets were concerned that the tightening of the FED monetary policy would lead to a recession. Still, they are broadly in line with historical averages and off their January 2018 highs. In relative terms, the risk premium asked by investors to hold equities in their portfolios versus government bonds is too high. This is particularly true in Europe. Therefore, given central banks liquidity injections there is potential for some further equity rerating from here (cf. chart below) which typically happens at this stage of the cycle. Within equities, cyclical and value stocks are still trading at an unusually high discount versus defensive and growth stocks which we think creates tactical investment opportunities. By comparison, bonds look expensive, with developed markets government bond yields trading 300bp below their 30-year average and credit spreads not far from historical lows. However, corporate default rates outside of energy should remain relatively well behaved, at least in the first half of 2020, which tends to make HY credit less expensive than it might seem. One area within the fixed income complex where valuations remain attractive is inflation breakevens as market pricing remains significantly below recent inflation readings and our expectations.
As far as Sentiment is concerned, equities are generally under-owned by investors as flows have hugely lagged equity performance, which is unusual, with a cumulative 300bn USD of outflows from equity funds over the last 18-months. But there are signs that investors are finally selling bonds and buying stocks, particularly in Europe where the underweight position is significant. European equity funds have returned to inflows after seeing 85 consecutive weeks of outflows, the longest stretch of outflows ever. The potential for additional inflows is therefore significant. This is all the more true that reduced political risks, particularly over Brexit, should support investors’ sentiment. Indeed, Boris Johnson’s ample victory means that a “no deal Brexit”, with all the uncertainty it entailed for U.K./EU trade, now comes with a virtually zero probability until the end of next year.
At last, technical factors remain clearly positive across asset classes. Central banks continue to pump liquidity into financial markets. The Fed is increasing its balance sheet by the largest amount since 2013; the European Central Bank (ECB) has just started rebuying and is purchasing around half of net non-financial investment grade credit supply; the Bank of Japan (BoJ) has been buying equities at a pace equivalent to 1.3% of market capitalisation per quarter since 2016. All in all, Fed, ECB, and BoJ balance sheets are likely to increase at a cumulative 1trn USD annual rate over the next 9 months. This should keep interest rate and credit spreads at low levels. For equities, the key buyer over the last 10 years was the corporate sector. We think this can continue as companies free cash flow is still covering dividends and buybacks.
Where does our MVST analysis leave us? We continue to be overweight equities with a cyclical tilt in our equity exposure and a preference for Europe and emerging markets. We also remain positive on Euro High Yield credit and constructive on Eurozone and US inflation breakevens, but maintain a neutral position on duration. As far as currencies are concerned, we expect the Euro to modestly appreciate against the dollar, with a target at 1.15 by the end of 2020, and have a preference for the Canadian dollar which offers a good carry.