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  • December 2020

2020 Multi-Asset Outlook

  • Nanette Abuhoff Jacobson, Global Investment and Multi-Asset Strategist; Daniel Cook, CFA, Investment Strategy Analyst

Any views expressed here are those of the authors as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.

Optimism with a pinch of realism

Key points

  1. While tail risks could reemerge, our outlook has brightened enough to consider less defensive positioning, including:
    • Equities over bonds
    • Within equities, US and Europe over Japan and emerging markets
    • High yield and securitized assets over investment-grade corporates
  2. Risks include a reescalation of the trade war, another leg down in global economic data, and US election momentum toward a more progressive Democratic candidate.

Our multi-asset views

Cumulative market flows (US$ billions)
Figure 0

Change is from previous quarter. Views expressed have a 6 − 12 month horizon and are those of the authors. Views are as of December 2019, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities.

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).

Figure 1

Where’s the love? Cash and fixed income suck up equity outflows

Cumulative market flows (US$ billions)
Figure 1

Source: EPFR | Asset class flows made up of ETFs and non-ETFs (> 99% non-ETF for money market funds), institutional and retail, and domestic and international. | Chart data: 5 November 2014 – 6 November 2019

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.

Global fundamentals: A bottoming process

We focus our attention on indicators that we think lead the purchasing managers’ index (PMI) — a measure of economic strength that tends to move coincidentally with the market. After turning downward for most of 2019, many of the indicators that usually lead the PMI by a few months seem to be bottoming. What’s more, we’re about at the point where the interest-rate declines of the last 12 – 18 months (about 100 bps) should begin to give growth a boost.

Europe

Overall, Europe’s economy performed poorly in 2019, but in the last few months of the year, several reasons for optimism emerged. Following a multi-year downturn in manufacturing, many of the short-term leads look to have bottomed. And while manufacturers suffered from a slowdown in exports, consumers were more resilient as the job market was steady and inflation low. Further, the decline in rates from late 2017 to late 2019 should provide some tailwind to the economy in 2020 (Figure 2). Given the improving macroeconomic picture and cheap valuations, we have raised our view on European equities to moderately bullish.

Figure 2

Past declines in interest rates should help economies in 2020

Cumulative market flows (US$ billions)
Figure 2

Sources: Bloomberg, Wellington Management | Chart data: December 1998 – November 2019. Eurozone manufacturing PMI data is lagged 18 months and is from June 2000 to November 2019. German bund 10-year yield data is from December 1998 – October 2019.

US

The US manufacturing economy is stuck in a tug-of-war between easier financial conditions and the uncertainty of the trade war. In the end, we think President Trump will likely choose the economy (his greatest strength in the polls; Figure 3) over being tough on China, in a bid to boost his reelection campaign. Meanwhile, consumers continue to enjoy solid job gains and a strong housing market. Thus, we look for uncertainty to continue to subside and the economy to maintain its solid if unspectacular growth. We continue to hold a moderately bullish view on US equities.

Figure 3

Trump still scores well on the economy

Cumulative market flows (US$ billions)
Figure 3

Chart data: November 2019 | Source: Real Clear Politics

Japan

The big question hanging over Japan’s economy is how it will recover from this past October’s VAT (value-added tax) hike. Signs thus far seem benign, a modest fiscal easing is in the pipeline, and our global industry analysts continually point to corporate governance reforms having a positive impact on returns. However, we haven’t seen a decisive turn in the leading indicators and still fear that a negative geopolitical event could push up the yen and pressure equities. We have a neutral view on Japanese equities.

Emerging markets

Emerging markets should benefit from an improving global backdrop and reduced tail risks. In China, targeted stimulus seems to be offsetting the confidence drag from the trade war, and the expansion of the services and consumer side of the economy continues unabated. We think China’s economy will muddle through with some upside potential. While headline data remains weak, underlying data suggests that the cycle has stabilized.

Elsewhere in emerging markets, we see areas of opportunity driven by positive reforms, including in Brazil and India, and areas of disappointment brought on by policymaking headwinds, including in Turkey and South Africa. Russia also remains a standout in terms of its fiscal discipline. Overall, we have increased our view on emerging market equities to neutral. We’ll need greater clarity on the global economy before we’ll be comfortable upgrading to a bullish view.

Credit enjoyed an impressive year in 2019, with Treasury yields and spreads falling.

Credit

Credit enjoyed an impressive year in 2019, with Treasury yields and spreads falling. Spreads are on the tight side now, but given the likelihood of rangebound global interest rates, strong demand from overseas, and our base case of no recession over the next 12 months, we think defaults will remain low too, so we remain moderately bullish on the asset class.

Within credit, we remain moderately bullish on high yield and securitized, but have lowered our view on investment-grade credit a notch to neutral. Spreads are about 100 bps over Treasuries, which is below the median since the index’s inception. Wider spreads can be found, but they are concentrated in 30-year BBB-rated companies, where we think the risk/reward is not appealing. Balancing these factors with favorable supply/demand technicals and healthy free cash flow, we think spreads will likely be rangebound.

We think securitized assets offer several potential benefits: structures that are default-remote and more diversified than corporate bonds; a way to tap into the relatively healthy US consumer; and spreads that compare favorably to corporate bonds of similar rating. We believe real estate and other consumer-related assets are attractive areas within the securitized market. We favor high yield given our more positive equity view, as well as potential opportunities resulting from the extreme dispersion between high- and low-rated bonds.

A better global backdrop should be favorable for emerging market debt EMD. However, we think EMD is more vulnerable than other sectors to global political uncertainty. Within emerging markets, we prefer local debt. We think lower rate risk and currency exposure give local debt the best upside potential in a risk rally.

Exploring downside risks

With our recommendations shifting toward more risk-seeking opportunities, we have been exploring the downside scenarios. One key risk is an escalation of trade restrictions that further damages the global economy. Hostile actions or rhetoric from the US or China could cause negotiations to break down. Our base case remains that there is sufficient motivation on both sides to ease tariffs given the economic harm they have already done.

Another tail risk that could reemerge is a hard Brexit. The UK general election is scheduled for December 12 and markets have cheered the lifting of uncertainty. However, a Labour-led coalition that aims to nationalize several UK industries and increase government spending would likely result in a negative market outcome.

We may also be wrong about the scope for asset owners to shift from defensive to cyclical sectors, as sentiment has already turned more positive from the extreme bearishness of August and September.

Finally, we are concerned about the US election. Should a left-wing candidate win the primaries and build momentum against Trump, we think the equity market would be vulnerable.

A related issue is populism, which is finding expression in protests all over the world. As we see in Hong Kong, these movements can be very disruptive and sink economies into recession.

Investment implications

Equities over bonds

We prefer equities to bonds as leading indicators have turned more positive, tail risks are reduced, and valuations in some risky assets are attractive. Past strong flows into cash and bonds could return to equities in 2020. We prefer Europe, where leads have bottomed and valuations are cheap, and the US, where we believe market risk is lowest.

Rotation is real

Long with our more positive view on developed market equities outside the US, we see the recent rotation into cyclical and more value-oriented sectors persisting. We think investors should consider adding exposure to financials and industrials. We also think health care is attractive now that US politics has shifted away from Medicare for All.

Credit looks attractive

We anticipate a solid but unspectacular year for the economy and risk assets in 2020. This is usually a good backdrop for credit investing. We favor shorter-duration investments in US high yield and securitized assets.

High-quality government bonds

We think yields could rise gently but value the unique diversifying role that bonds can play in a portfolio. If we are wrong and growth sputters or tail risks reemerge, high-quality government bonds are likely to outperform.

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