Investing at economic crossroads

Q: How should investors take stock of the macroeconomic climate for 2020?

A: Global economic growth peaked in mid-2018 and has been slowing ever since. This has been happening across economic regions, and governments are seeking to harness a wider range of economic policies to boost growth, or at least mitigate the worst effects of the US-China trade war.

The risks of trade and currency wars, along with a battle for technology leadership, have been dragging down business confidence and investment.

Political risks remain high given next year's US presidential election, compounded by ongoing uncertainty about the terms of the UK's departure from the European Union and the prospect of further elections in Continental Europe. This has created a climate of malaise and a serious lack of visibility that could adversely affect companies' recruitment decisions and consumer confidence as we move into next year.

Q: What are some risks on the horizon?

A: For 2020, it is vital that the late-2019 slowdown does not turn into a recession, but instead is replaced by a stabilisation period followed by a rebound like that seen in 2015-2017. Financial markets and economic agents are looking to those responsible for economic policy, and above all central banks, to support the cycle and remove the threat of widespread recession.

This highly accommodative monetary environment is likely to last into 2020 with further rate cuts expected in the coming quarters. We should also see moves to ensure abundant liquidity. as occasional bouts of illiquidity have recently suggested that money is flowing less easily through economic and financial channels.

While monetary policy can help, fiscal stimulus is the catalyst for broader growth momentum. However, the global economy is in the early stages of this transition, which creates a risk because new spending programmes may prove slow to arrive while additional monetary policy support will reach its limits.

A truce in the US-China trade war and a resolution to the UK-EU Brexit drama appeared on the horizon in late 2019, although tension remains high in the Middle East, posing a threat to this reduction in geopolitical risk.

Q: Against this backdrop, how should investors position their portfolios?

A: Investors should seek to re-position in favour ot equities while actively managing interest-rate risk in their global bond exposure in 2020. The economic boost from stimulus measures adopted around the world throughout 2019 should support this transition. Admittedly, however, managing the risk 01 this shift will be just as important for investors from a more tactical point of view.

Global equities should also benefit from a rebound in US and global growth and increased expectations as we enter 2020, just as we saw in 2011/12 and 2015/16.

Indeed, with central banks taking action in the second half of 2019 to reduce the likelihood of a downturn in the credit cycle, the headwinds butteting investors through much of the past year are at last beginning to ease.

With US equity valuations high, the key driver of returns in 2020 will be an improved outlook for earnings growth, which fell close to zero in late 2019.

Though expectations for 2020 appear optimistic as we enter the new year. more moderate expectations combined with improving growth prospects in the coming year bode well for equities generally.

Moreover, while US equities have outpaced their global peers since the end of the global financial crisis, their outperformance is beginning to ease. Indeed, continental European equities - lacking the valuation obstacles of their American counterparts - have kept pace with US equities in 2019, aided by a weak currency.

With the Brexit-related overhang set to ease, both UK and continental European equities stand to benefit from fiscal policy momentum moving into the new year. Although investors have sought refuge in global European/UK corporates over the past year, a pivot to more domestic companies is emerging as an opportunity as these headwinds fade.

While emerging equities historically benefit from improving global growth, we believe that an active stock-picking approach in the emerging-market universe will add significant value.

In China, we believe that key domestic consumption trends offer opportunities, especially in the onshore A-share segment in 2020.

With earnings expectations still modest. investors should also seek to use the predicted increase in volatility in global foreign-exchange markets to enhance portfolios' total return prospects. With the strong US-dollar trend of the past two years close to exhaustion, tactical opportunities in the currency market should present themselves in the new year.

The transition from monetary to fiscal support for the global economy may not be a smooth one, and so the way this shift is handled will be an important risk-management focus. Longer-duration government bonds may provide tactical opportunities, and increasing exposure to "risk-ott" assets will be an important diversification move in 2020. We believe that safe havens - the Japanese yen and Swiss franc. as well as gold - present attractive diversification opportunities.

Q: How should investors be more selective of bonds this year?

A: For tixed-income investors, 2019 has been a good year because of sharply falling bond yields around the world, but risk management should be the focus for 2020. Encouragingly, renewed monetary easing and balance-sheet expansion by both the US Federal Reserve and European Central Bank represent an effort to contain a sustained widening in credit spreads that might derail the nascent global economic recovery. At the very least, however, investors are likely to tace increased volatility in bond markets, a process that began in 2019.

As we enter 2020, fixed-income investors should take comfort in the fact that the US and European central banks are committed to stabilising broader financial conditions and, more specifically, local credit markets. As a result, hold-to-maturity corporate credit exposure should prove valuable. even during this period of increased volatility. In exchange, investors will need to moderate their interest-rate exposure, especially anticipating an acceleration in fiscal spending as we move through 2020.

Emerging-market bond investors should benefit from a more helpful global backdrop as well. However, the near-term and idiosyncratic risks in this segment are more pronounced than in US or European credit markets. In particular. emerging-market bonds lack the same central bank backstop that the Federal Reserve and ECB are providing to their home bond markets.

Moreover. as we have seen in 2019. the emerging-market bond universe is exposed to more China-specific risk. We expect China to continue focusing on domestic reform during the trade détente with the United States, and so emerging-market bonds may lack catalysts comparable to those of developed-market credit in 2020.