2019 has been a good year so far for both equity and bond markets.
Looking ahead, we expect to see some bond, equity and real estate markets offer attractive returns in 2020 and 2021.
Therefore investors should look to put cash to work, moving out of defensive assets but being selective in what they buy.
A worthwhile starting point is to think about valuations.
This is especially true for equity investors.
Since last winter, when there was a short-lived sell off on trade war concerns, stock markets have subsequently recovered.
The US equity market is richly valued and therefore needs a continued stream of good news.
Emerging markets or Pan European assets are attractively valued as long as cash flows convince investors that dividends can be sustained.
Elsewhere, valuations are more of a headwind to most government bond markets, unless a recession or another major shock forcing large scale changes to inflation and interest rates unexpectedly appears.
Turning to the economic risks facing the world economy, our starting point should be examining various issues and imbalances in different countries.
Undoubtedly, there are worries about some areas – China’s household and financial and local government debt; US corporate debt; some emerging market debt; housing markets in advanced economies; the risk of inflation from tighter labour markets; and the pressures on margins among smaller companies.
On balance, however, we see these issues as manageable due to very low interest rates, even in a world of slow growth.
Company cash flows remain key, as does the willingness of central banks and governments to respond quickly as and when tensions appear.
Indeed, the array of political and policy risks into 2020 looks better balanced than in the summer.
Households in Europe are incurring negative returns on bank depositsWe have considered political and geo-political shocks related to Brexit, US-China trade or Middle East tensions.
One helpful aspect is that there are positive signals that fiscal policy could become more expansionary in 2020-21, especially in Europe and Japan.
Central bankers such as Christine Lagarde are going the extra mile in warning about the relative ineffectiveness of monetary policy.
One side effect of the latest easing of monetary policy in the US, and especially Europe, is the emphasis it places on ‘yield’ as a factor when creating successful portfolios.
Insurers and pension funds are dealing with the consequences of $12 trillion of negative yielding bonds.
Households in Europe are incurring negative returns on bank deposits.
The rationale for equity income, corporate debt, or real estate is clear – look for income as long as future cashflows are considered sufficient.
Easier fiscal policy is just one response by governments to the populist pressures being seen in many countries – heightened regulation, trade protection, nationalisation and national champions are other solutions being widely touted.
Populism has built on decades of slow incomes growth, austerity in public spending and deteriorating job security.
In 2020, it could be the source of more political stories in developed or emerging countries.
Early elections in Germany or Italy and the result of the US Presidential election are just some instances.
As an example, short-lived drawdowns of 10 per cent or more in equity markets might be an obvious consequence.
Sadly at times of risk aversion, correlations between asset class movements become highly co-ordinated. Portfolio construction becomes more important.
Putting politics to one side, the key driver for 2020 remains corporate cash flow.
We expect profits to be sufficient to meet dividend expectations, limiting any rise in corporate bond defaults, and allowing the yield premium demanded by most real estate investors to be met.
Our economic forecasts are consistent with slightly better top line revenue growth in 2020, and better still in 2021.
Late cycle margins pressure should be contained by cost-cutting, productivity enhancements and mergers and acquisitions to create economies of scale.
Put simply, the monetary and fiscal easing seen in 2019 – and expected for 2020 – means recession risks are limited, but not negligible, as there is potential for policy errors such as the reappearance of a full blown trade war.
To sum up, we favour a diversified portfolio – overweight global equities on growth prospects, especially emerging markets and Japan; global real estate for its relatively attractive yield, particularly offices, logistics and specialist areas but not retail, which usually faces structural pressures; and finally, selective approaches to emerging market, investment grade and high yield corporate debt reflecting increasing pressures in some countries or sectors such as automotive or energy.
As confidence grows about the future, emerging market assets are modestly favoured over developed – both equity, and especially debt.
Andrew Milligan is global head of strategy at Aberdeen Standard Investments
