For most of 2019, our gloomy view of the global economy — including heightened tail risks related to Brexit and the US/China trade war, and our lingering concern that central bank stimulus would fall short of market expectations — kept us sheltered in safer assets. As we prepare for 2020, we are encouraged by improving leading economic indicators, receding tail risks, and the fact that markets are no longer baking in much central bank support. While sentiment surveys have improved in recent weeks, flows and positioning data remain quite defensive, leaving room for a boost to risky assets as investors set allocations for the new year (Figure 1).
The recovery in economic data is still fragile and tail risks could reemerge, but we’ve seen enough to at least dip a toe back into risky assets.
The recovery in economic data is still fragile and tail risks could reemerge, but we’ve seen enough to at least dip a toe back into risky assets. We prefer equities to bonds, and within equities prefer Europe and the US to Japan and emerging markets. We expect risk-free rates to rise gently, but we still find some areas of credit markets attractive. In particular, we prefer a “barbell” of high yield and securitized to investment-grade corporate bonds, emerging market debt (EMD), and bank loans. We think high yield can benefit from positive equity performance and securitized can provide better risk/reward than investment-grade corporates. We have lowered our view on commodities to moderately bearish as we see less need for precious metals as a hedge and few reasons to expect much higher inflation — thus our preference for industrial metals and natural resources as sources of cash.