Tentative signs have emerged that a trough in global economic activity growth is beginning to form, although the strongest evidence is coming from soft rather than hard data at present, says Aberdeen Standard Investments in a recent publication. Their global growth forecasts support that sentiment, driven by the expectation that geopolitical uncertainty will moderate at the margin, while the significant monetary support delivered this year supports the real economy. However, they expect any recovery in global growth to look “much more like an L-shape than a V”.
The fundamental drivers of geopolitical risk are still in place, constraining business investment, and monetary policy efficacy is lower than at earlier stages of the current expansion. “Indeed, we expect the world’s two largest economies (the US and China) to actually slow further in 2020, which will lessen the scope for improvement in those economies that were much weaker in 2019″.
Although markets have priced in growth stabilisation, the asset manager doesn’t think they price in a moderate recovery in industrial output and corporate earnings. As such, it expects further gains in the price of risk assets as we roll forward into 2020.
The strategy in global markets
When it comes to global markets, ASI identifies an “upside asymmetry” for some higher carry investments. “Risk assets are rallying and diversifiers are selling off, but changes in ‘hard’ data seem too insignificant to be the catalyst yet”.
However, the direction of ‘soft’ information has been noticeably more positive as optimism is rising that US-China trade tensions will abate; monetary easing from the Federal Reserve and other central banks has been substantial; and there has been an uptick in some leading indicators.
“As investors, our perennial question is whether markets have accurately adapted to these changes or overshot economic reality”, the asset manager points out. Its “tactical asset allocation process” offers a useful way to consider this.
In this respect, in August, they defined their ‘late cycle slowdown’ scenario as a world where the Global PMI was below 50, global EPS growth was somewhat negative and US core inflation was materially below target at 1.5%. “That was fairly close to the economic reality at the time and yet, under that scenario, we forecast equity returns of only a further 5% decline”.
By contrast, their ‘moderate recovery’ scenario began to reflect equity upside of 10-20%, depending on the region. This asymmetry had been widening at the same time that investors were widely considered to be bearish in mindset (AAII surveys) and positioned in quite a risk-averse way (BAML Fund Manager Survey).
“The relief rally we have seen has therefore been in line with the modest improvement in trade rhetoric, the ongoing easing in monetary policy and the apparent basing in leading indicators that catalysed an improvement in investor sentiment”.
Looking forward, ASI thinks they must assess whether asymmetry still exists or whether further momentum can only come from hard-data improvements. Their economists forecast that growth is going to trough but that the recovery may look more L-shaped than V-shaped, so, for their tactical asset allocations scenarios, their expectation is for “an environment that looks more like a ‘moderate recovery’“. This would see the global PMI rise a little further, a return to modest earnings-per-share growth (single digit) and gently rising inflation.
“Despite this scenario being more optimistic than a continued slowdown, the rally we have already seen leaves us forecasting only a further 5% upside in the US, Japanese and European equity markets in the near term”. If growth does improve, the asset manager sees potentially more upside in UK and EM equities (10-20%) given their more elevated risk premiums.
Importantly, ASI considers the previous asymmetry of upside-to-downside equity returns has now evaporated and, at this stage of the recovery, sees more asymmetry in their credit forecasts than for equities. In that sense, they believe spreads in high-yield and EM are still fair and their carry returns more backstopped by monetary easing. “As a result, we see these credit markets as providing better risk-adjusted returns, even though we continue to benefit from some equity exposure in particular markets”.
For Funds Society, Madrid