2020 will probably not be a great year for bonds. The low interest rates could even precipitate a shock to the financial system eventually. The outlook for equities is somewhat more promising, even though it’s difficult to grow earnings in the current low-growth environment, says Chris Iggo, CIO of AXA IM, in the second part of our 2020 outlook series.
«The cycle is quite long, and parts of the economy look stretched. But we’re probably still in a world where equities will outperform bonds because a bear market is unlikely. And companies are issuing bonds to buy back shares, especially in America. This leads to a relative shrinkage of equity markets, and thus speaks in favour of equities as well, relative to bonds.
This doesn’t mean I expect a bad year for bonds. But it will probably be a rather boring year. My base case is the Fed will be on hold for the foreseeable future. I even wouldn’t rule out completely recession risk coming back. But it’s very rare you get a recession in an election year in the US unless there’s some kind of economic shock. 2021 gives more of an opportunity to see weaker growth in the US. On the other hand, some kind of agreement with China is likely as it would suit Trump. It would also be a relief to the corporate sector to some extent, and would allow a modest uptick in growth. Bond yields may rise and yield curves steepen, but only slightly because there is so much demand for yield, and because the Fed will remain on hold.
In Europe, I don’t see Madame Lagarde changing the course of monetary policy. Only evidence of governments in Europe being ready to engage in serious fiscal stimulus might change the outlook. That would push bond yields higher. But in Germany there is no particular appetite to increase borrowing. The interest rate outlook is therefore rather dull, as I don’t see any drivers for rates to go down either.»
Brexit will bring the action
«The action in Europe is likely to come from Brexit. Johnson will get his withdrawal bill through, but that will only be the start as we will then move on to the real important stuff, which is a trade deal between the UK and Europe. This could bring back a lot of uncertainty. The UK equity market is underowned and has underperformed though, so there is room for some positive surprises there.
2020 will be mostly about managing the downside. As the effects of QE are waning, we can expect volatility to rise. And without QE, credit spreads would probably be higher. Cyclical parts of the market will also be quite weak if something bad happens. At the same time, political risk is on the rise, especially in emerging markets such as Hong Kong, Iraq, Lebanon and various Latin American countries. We were overweight EM during the first part of this year, but are less inclined to be overweight now. We still like short-duration high-yield, bank debt in Europe and parts of the structured credit market.
My overall outlook is quite gloomy. We will see lower growth because of demographics, and the world is changing from embracing globalisation to opposing it. Moreover, world power is up for grabs as the US is turning inward. This will not change in the foreseeable future. In Europe, the persistently low interest rates and its effects on banks and insurance companies could eventually cause these institutions to fail and lead to a shock to the system.»