December is usually a very festive month. As the year is ending, it is also the month during which the asset allocation team writes up its Outlook, a document that sums up the team’s convictions and strategic views for the upcoming year. There were upgrades and downgrades of asset classes, which are noteworthy, especially in a context of equity market highs and the absence of real alternatives, with rates doomed to stay low. The core scenario remains that of bonds yields slightly creeping up, with equities expected to post positive – but lower – performances.
Equities vs. bonds
We still favour equities over bonds as the 2020s start with hope.
Current research and analyses are pointing towards a bottoming out of the cycle and yet also to lower expected returns. Equity risk premium is now back to a top level, thereby building a case for equities over bonds. More specifically within equities, investment opportunities can be found in value and cyclical stocks as well as thematic investments that draw on long-term convictions.
Equities
US: from trade to electoral uncertainty
US equities are a core holding. They deserve the current safety premium but the upcoming 2020 US presidential elections are likely to trigger more uncertainty than usual and for several reasons:
- no campaign season has ever run concurrent with an impeachment process;
- no incumbent has ever suffered from such a low approval rating when the US unemployment rate is so low and US stock market gains have been so strong; and
- modern US Presidential politics has never pitted a populist President from one side of the spectrum (Trump) versus populists from the other side (Warren, Sanders).
Given the current conditions, electoral uncertainty is likely to take over and the trade war to take a back seat. It would be good news for global markets, as the trade war has negatively impacted the world business climate, the volume of globally traded goods and global earnings, sparing the US somewhat relative to the other regions.
The absence of further escalation should give breathing space to corporates and benefit equity markets outside of the US.
Our strategic views on the US region herewith becomes neutral.
Europe: the tide is turning
In Europe, the tide is turning. The region had been shunned by investors. Throughout the past year, it had to muscle its way through the global economic slowdown, Germany barely kept a recession at bay, political turmoil in Italy and lately Spain, not to mention the ongoing negotiations surrounding Brexit. But investors’ inflows are slowly coming back and the tide is turning.
European equities have, like Japanese equities – and unlike US equities – a value bias. Both regions should continue to be a catalyst for regional outperformance, benefiting from the rate recovery.
Currently, the relative valuation of “value” sectors remains close to trough levels, especially if we look at the European automotive sector and the euro zone banking sector. They are currently strongly discounted, yet have the potential to catch up if our macroeconomic scenario pans out: growth slowing further without triggering a recession.
There is also hope – and budget space – for a fiscal plan. It is highly encouraged by the European Central Bank and could help stimulate the economy. For investors, it could create, in longer-term growing underlying markets, investment opportunities in climate change, environmental infrastructure and energy transition.
Our strategic preference will go to euro zone equities where we are positive and, to a lesser extent, to the UK, as we become neutral.
Emerging markets: the 2020s start with hope
Emerging market equities should benefit from the restoration of the growth differential. We also expect more attractive expected returns than in developed markets.
The IMF forecasts growing GDP in Emerging markets, which outperformed in the 2000s, but have underperformed in the 2010s, having to adjust to their massively growing population and the growing middle class.
Hence, expectations are improving for the next decade, the 2020s.
In countries stimulating their economies via infrastructure projects, the growth in Fixed Asset Investments (FAI) should become higher than their respective GDP growth.
Research have shown that their investment needs in economic infrastructure, including China, Eastern Europe, Latin America, the Middle East, India and Africa, should more than double by 2035 compared to the 2000-2015 period. Covering the needs for economic infrastructure will benefit sectors in power supply, water supply, road, rail, port and airport improvements.
Our strategic view on Emerging markets becomes positive.
Bonds and currencies
We are underweight bonds, keeping a short duration. The macro-financial backdrop will favour carry. One of the highest carry can be found in emerging debt.
We also remain invested in investment grade bonds. The global context, with an easing ECB, remains supportive, despite the strong spread-tightening since the beginning of the year. Carry-to-risk is interesting and the low-yield environment is supportive of credit.
In the currency universe, we remain long Yen.
We have exposure to gold, which remains an attractive hedge in a context of negative to low rates.
