Signs that the global economic backdrop has stabilized have begun to emerge in recent weeks. Additionally, central banks seem committed to supporting not just real economic activity but orderly financial markets, and in doing so they seem to be willing to err on the side of being more dovish. This has encouraged investors, many of whom had been positioned cautiously, to reduce their underweight exposure to equities, and on balance this trend should continue in the early part of 2020.
At the same time, the strong returns generated in 2019 are unlikely to be repeated. While central banks may be inclined to be supportive, with interest rates in much of the world in negative territory and not a great deal higher elsewhere, there is a legitimate debate as to how effective monetary policy is in raising inflation or boosting economic activity.
Equities at a Crossroads?
Looking beyond the first quarter, equities face a number of headwinds, not least poor productivity and weak investment. That places a natural speed limit on growth. Companies have been blaming policy uncertainty for their reluctance to invest; this looks set to persist.
Take tensions between the United States and China, for example. While an apparent softening of positions may have in recent weeks raised hopes an escalation of the dispute can be averted, this issue is not going to go away in a hurry.
The U.S. presidential election is another source of uncertainty. Regardless of the outcome, the United States seems likely to continue with its tough approach to China, and there will be no desire to tighten fiscal policy. But beyond that, there is a broad spectrum of policies voters are choosing from, so the range of factors both companies and investors have to consider will be wide and change significantly over the next 12 months. It is likely that a number of corporate investment projects will be deferred.
U.S. Stocks Have Had the Best Decade Since the 1950s
Sharpe ratio for the S&P 500®
Within equities, the Japanese market looks relatively attractive. Whereas earnings in the rest of the world are expected by consensus to grow by around 10% in 2020 after disappointing in 2019, in Japan little to no recovery is expected over 2018 levels. This suggests there is less scope for disappointment if growth is weak, and some upside if recovery takes hold.
Moreover, the Japanese stock market yields around 2.1%, in stark contrast to the negative yield on ten-year Japanese government debt. Elsewhere, the U.S. stock market offers a dividend yield (1.85%)—broadly comparable to the yield on 10-year government bonds (1.75%). In addition, at a time when investors have suddenly rediscovered their appetite for value investments, Japan has a strong claim to being a value play among equity regions.
De-risking with U.S. Treasuries
While government bond yields remain low by historical standards, they seem unlikely to begin a prolonged march higher. Since government bonds remain one of the few reliable methods of diversifying a portfolio of risky assets, and given the downside risks to economic growth, they continue to have an important role to play in diversifying multi-asset portfolios.
U.S. Treasuries are a favored investment. Not only do they offer relatively attractive yields, there is more scope than elsewhere for monetary policy to be eased, in our view. The Australian and Canadian markets could also do well given the prospect for easier monetary policy as central banks respond to weaker domestic conditions.
Neutral on High Yield
As for other bond markets, we are neutral on high yield. While it still offers a reasonable spread over Treasuries, the average quality of high-yield credits has deteriorated as leverage has gone up. Furthermore, high-yield bonds have been trading closely in line with equities, meaning they are not as useful a diversifier of risk as they have been before. On the other hand, emerging market debt, in both hard and local currencies, seems to offer sizeable diversification benefits, and is favoured for this reason.
Prior to joining Aviva Investors, Sunil Krishnan was a Senior Multi-Asset Portfolio Manager at Santander Asset Management, having been Head of Global Asset Allocation at Hermes Investment Management and Head of Market Strategy at the British Telecom Pension Scheme. He also spent 10 years at BlackRock Investment Management in a number of roles including portfolio management, research and strategy. He holds an MSc in Economics from Birkbeck College, University of London and an MA in Philosophy, Politics and Economics from Balliol College, University of Oxford. He is also a CFA® Charterholder.
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