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Equities face headwinds in 2020

Equities face headwinds in 2020

Signs the global economic backdrop has stabilised have begun to emerge in recent weeks.

Additionally, central banks seem committed to supporting not just real economic activity but orderly financial markets, and in doing so they seem to be willing to err on the side of being more dovish.

This has encouraged investors, many of whom had been positioned cautiously, to reduce their underweight exposure to equities, and on balance this trend should continue in the early part of 2020.

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At the same time, the strong returns generated in 2019 are unlikely to be repeated.

While central banks may be inclined to be supportive, with interest rates in much of the world in negative territory and not a great deal higher elsewhere, there is a legitimate debate as to how effective monetary policy is in raising inflation or boosting economic activity.

Looking beyond the first quarter, equities face a number of headwinds, not least poor productivity and weak investment.

That places a natural speed limit on growth.

Companies have been blaming policy uncertainty for their reluctance to invest; this looks set to persist.

Tensions between US and China

Take tensions between the US and China.

While an apparent softening of positions may have in recent weeks raised hopes an escalation of the dispute can be averted, this issue is not going to go away in a hurry.

The US presidential election is another source of uncertainty.

Regardless of the outcome, the US seems likely to continue with its tough approach to China and there will be no desire to tighten fiscal policy.

But beyond that, there is a broad spectrum of policies voters are choosing from, so the range of factors both companies and investors have to consider will be wide and change significantly over the next 12 months. It is likely that a number of corporate investment projects will be deferred.

Within equities, the Japanese market looks relatively attractive.

Whereas earnings in the rest of the world are expected by consensus to grow by around ten per cent in 2020 after disappointing in 2019, in Japan little to no recovery is expected over 2018 levels.

This suggests there is less scope for disappointment if growth is weak, and some upside if recovery takes hold.

Moreover, the Japanese stock market yields around 2.1 per cent, in stark contrast to the negative yield on ten-year Japanese government debt.

Elsewhere, the US stock market offers a dividend yield (1.85 per cent) broadly comparable to the yield on ten-year government bonds (1.75 per cent).

In addition, at a time when investors have suddenly rediscovered their appetite for value investments, Japan has a strong claim to being a value play among equity regions.

While government bond yields remain low by historical standards, they seem unlikely to begin a prolonged march higher.

Since government bonds remain one of the few reliable methods of diversifying a portfolio of risky assets, and given the downside risks to economic growth, they continue to have an important role to play in diversifying multi-asset portfolios.