The world economy is showing signs of recovery. Over the fourth quarter, investors have anticipated a more stable macro environment by driving up equity market valuations. The ‘very large Phase One Deal’ that was announced by President Trump on Twitter earlier this month may not be as comprehensive as suggested. But markets have given Trump the benefit of doubt and have continued to move up.
We have agreed to a very large Phase One Deal with China. They have agreed to many structural changes and massive purchases of Agricultural Product, Energy, and Manufactured Goods, plus much more. The 25% Tariffs will remain as is, with 7 1/2% put on much of the remainder….
— Donald J. Trump (@realDonaldTrump) December 13, 2019
Markets are also optimistic about the prospect of Christine Lagarde shaping Europe’s monetary policy for most of the upcoming decade. But whether she will succeed in convincing European governments to provide meaningful fiscal stimulus is another thing. The reduced uncertainty regarding Brexit has boosted investor sentiment. The size of prime minister Johnson’s parliamentary majority may make it easier for him to conclude a trade deal with the EU. However, negotiations on the future relationship are very unlikely to be concluded by the end of next year. Brexit is therefore likely to come back to haunt investor again by the second half of 2020.
This is the investment outlook for 2020 in a nutshell. Over the next few days, we are providing you with the outlooks of three investors of prominent global asset managers. We kick off with Paul O’Connor, head of multi-asset at Janus Henderson Investors:
«We have now had seven consecutive quarters of weakening macro momentum, but I see reasons to believe there will be a change in this trend as we’ve seen small rate cuts and a big easing in market rates. This time last year you had to pay 8% as a high-yield issuer. The mortgage rate for US homeowners is now a lot lower than a year ago as well, so the macro momentum can improve. The key factor to sustain market confidence is the resolution of the trade war between China and the US. I indeed expect a phase one agreement so I am optimistic on this. The trade deal will have a very big impact on market sentiment. If we get a positive outcome, markets will reduce the probability of recession risk though the initial agreement will probably be limited in scope.
If we get evidence the recovery is sustained, we will get a rotation away from duration to more cyclical risk that could run much further. We have anticipated on such a development by taking a tactical overweight to EM equities, Japan and European equities and to value scenes within them. We have reduced our weighting in investment-grade bonds to lock in profits.»
Recession risk
«But at this stage of the cycle have to recognise that recession risk can’t be dismissed. A year ago we thought the Fed was on its way to increase rates three or four more times. We’ve had unusually responsive central banks in the sense that they’ve helped us to avert a recession. But the cycle is tiring, and we are at the end of the QE era. So our focus has been on mid-risk assets: emerging market debt, high-yield bonds and low-risk equity.
Going forward, markets will focus a lot on fiscal policy. But countries that have the greatest fiscal resource will not use it. If the global economy does lose momentum or if inflation expectations come down, we will see more pressure for fiscal stimulus. But countries with tight labour markets will struggle to rationalise fiscal stimulus. Tax incentives could be effective there but government spending won’t. We need some form of economic crisis to deliver a fiscal response. Peripheral Europe has low borrowing costs and would see more powerful multipliers from fiscal stimulus.
The current Brexit ceasefire could be much shorter-lived than markets expect despite the stable majority for the Conservatives. My concern is that markets haven’t sufficiently priced in the form of Brexit the former government wanted to pursue, which is a hard Brexit. If the government wants an end-2020 Brexit, it will be very limited in scope. Very limited progress on services is to be expected next year. That form of Brexit will leave lots of uncertainty for many years to come. It will weigh on the economy and on macroeconomic confidence. The outlook here is not very encouraging.»