World at Large

The current economic slowdown should come to an end in 2020. The global economy is showing signs (the so-called ‘green shoots’) that growth in 2020 should pick-up modestly, aided by a détente in global trade frictions and stimulative central bank policies. We see an economic environment where corporate earnings growth will be sufficient to support equity market gains. We expect that bond yields will remain low but have a modest upward trend, commodity prices will improve, and the U.S. dollar will weaken.

Global equity markets have moved sideways for 22 months (January 2018 through to October 2019) and are now breaking out to the upside. Equities are moving up in anticipation of improvement in the macro-economic environment into 2020. In contrast to 2019, where many indictors were slowing, these same metrics are starting to turn the corner, pointing to growth in 2020 (see Exhibit 1.1 – Green Shoot #1: Embattled Global Manufacturing Sector Looking Toward Improvement).

The growth won't be robust, but it will at least be moving from a downward trend to a stable or upward trend. In short, what were headwinds in 2019 will turn benign or become tailwinds in 2020.

The new normal

As the global economy exits its third slowdown since 2009, we don’t believe equity gains will match those from the previous two recoveries (~50% and ~25%), nor will bond yields climb back to the heights of either recovery (U.S. 10-year bond yields peaked at 3% in 2014 and 3.25% in 2018). In the times since, debt levels have steadily increased, stimulative monetary policy efforts now face diminishing marginal returns and growth is running-up against the constraints of tight labour markets, while trade frictions restrain business investment. Even if trade frictions ebb, we don’t see a complete return to normalcy. The uncertainty unleashed thus far is already disrupting global supply chains, levelling additional costs on the global economy. Add in the increased costs of adopting business processes that move toward a more environmentally sustainable world and the conclusion leads to a reflation scenario that will likely deliver less oomph.

Longer term, epochal shifts are taking place at the expense of global multinational corporations. A retreat from globalization, greater environmental stewardship and shifting global hegemonies are realities that will eat into the profit margins of the companies whose shares make up the bulk of the global investing universe. These developed world multinational companies have benefitted most from a half-century of expanding globalization and trade, low-cost use of the environment and protection under the United States’ security umbrella.

To gauge equity expectations, we look to earnings growth and valuations.

  • Earnings estimates for 2020 remain elevated, but under the right set of conditions (such as easing trade concerns, accommodating central banks, a weakening U.S. dollar and less onerous year-over-year comparisons), earnings in the mid to high single-digit range are achievable.
  • Elevated equity valuations will be supported by a low-inflation, low-yield environment (rising, but still very low). Central banks have put rate hikes on hold and are providing ample liquidity, along with the increasing confidence that earnings will show growth. Canadian, international and emerging market equities, being more cyclically oriented and sporting cheaper valuations, are poised to outperform more expensive U.S. equities.

All in, we forecast 2020 equity returns in the 6% to 13% range, depending on the market in question.

As always, hurdles remain. Of the four contributors to economic growth (consumers, businesses, governments and trade), the strength of the global consumer has held the current slowdown in check.

  • The consumer can’t be expected to do all the heavy lifting indefinitely; success in moving forward requires the other cylinders to begin firing. Policymakers need to provide an environment that lifts the extreme uncertainty brought on by trade frictions and Brexit and paves the way for the return of ‘animal spirits’ which is the natural, steady-state for both households and businesses.
  • We believe businesses will return to expansion mode as they receive sufficient reprieve from geopolitical uncertainty. Indeed, the pressure on businesses is building – the ability to meet demand from bloated inventories appears to be coming to an end (see Exhibit 1.2 – Green Shoot #2: U.S. Inventory Cycle Starting to Turn). Increased business spending will result from demand that holds steady, or slightly improves.
  • Government spending, while not a net detractor in 2019, has room and incentive to expand throughout 2020. We do not foresee any global fiscal contraction. Japan is launching a stimulus package, recognizing that monetary policy is not enough. Japan’s experiment with negative interest rates (resulting in governments being paid to borrow) is alluring and ostensibly makes government spending appear to be an easier choice. Europe faces a similar choice but has yet to commit to any sweeping fiscal boost, despite demands from a variety of voices and ample capacity in the region’s main (and faltering) economy, Germany, to do so. In North America, governments on both sides of the border should increase expenditures. The 2020 U.S. election will encourage a liberal sprinkling of program spending and make shutdowns and debt ceiling limitations politically unpalatable. Canada’s Liberal minority government will likely spend more in an attempt to conciliate and hold power.
  • Despite trade frictions and swirling uncertainty, global trade volumes are already showing signs of improvement as the world adapts and continues to figure out a way forward. While September’s trade reading was weak, world trade volumes for July and August were the first back-to-back months of increase in 12 months and the three-month trend has turned positive (see Exhibit 1.3 – Green Shoot #3: Flatline for Global Trade Volumes Reaching Exhaustion). Economies and stock markets that are hypersensitive to trade (such as Germany, South Korea, Taiwan and Japan) are showing nascent signs of improvement, as are most commodities and the semi-conductor space. We expect global trade to turn from a drag to a slight benefit during 2020.

While we are constructive on the macro-economic outlook, trade frictions and Brexit uncertainty will have to clear meaningfully to pave the way for this scenario to come to fruition. While the developments of mid-December are encouraging, and some interim resolutions are preferable to descending further into chaos, it’s important to note that the U.S./China trade truce is simply a truce – not an end to the war. Additionally, the Conservative win in the U.K. ends the debate over whether or not they are leaving but that may end up looking like the easy part. Next year brings the challenge of negotiating a comprehensive trade deal between the U.K. and the eurozone, and likely the U.K and others, notably the U.S. The bottom line is risks remain and we believe it is prudent to factor these risks into our asset mix stance; thereby tempering our enthusiasm for risk assets and improving our appetite for safe havens.

Equity markets have already moved to price in a rosy scenario for trade, supportive global central banks and the expectation that the earnings recession will come to an end in 2020. While our full-year return scenarios leave room for further growth, equities likely require more time to consolidate recent gains (a 5 to 7% correction in equities would pique our interest) and greater evidence (versus just hope) that the clouds are indeed going to part in 2020.

Conversely, bond yields appear to reflect a degree of pessimism inconsistent with our base-case scenario of modest improvement. While yields have been in an uptrend since their 2019 lows back in August (making higher highs and higher lows), their attraction is more muted than if yields were currently moving toward the upper-end of their trading range (a 35 to 40 basis point move higher from Nov. 30, 2019 levels for Canadian sovereign bond yields would whet our appetite for more fixed income). 

Year-to-date returns for most asset classes appear eye-popping despite most being merely a by-product of a recovery from the steep declines of Q4 2018. This is not the case for fixed income. Strong YTD returns for fixed income (8.2%) reflect a structural shift to lower bond yields due to the abrupt about-face on monetary policy early in 2019 by global central banks. That shift knocked yields down by about 0.5% early in the year and is responsible for roughly half of the YTD returns in 2019. The environment now is one where bond and money markets continue to expect further central bank easing. Yet, if the environment improves, that easing is not likely to be necessary or forthcoming. We don’t believe bond yields need a significant adjustment higher because central banks are currently on hold with a bias toward easing (versus tightening). It is noteworthy that if yields move higher by 0.25 to 0.50% (in an improving macro-economic scenario), that still represents a historically low yield environment. Importantly, despite a slight move up, we see a yield environment that remains accommodative: one where businesses and households can access and afford credit and one that doesn’t require a downward adjustment to equity market valuations.

Fixed income’s risk-mitigating qualities remain a significant attraction: bond yields are high enough to provide ample room for yields to fall should a risk-off scenario unfold. As a result, investment-grade fixed income continues to be capable of providing risk mitigation within portfolio construction.

Bottom line: Our current tilt to the defensive side of neutral (i.e., slight underweight in equities and slight overweight to fixed income) continues to offer exposure to participate in equity market growth without overreaching for risk.

  • Our 2020 Capital Market Outlook calls for high single-digit equity price gains, with select markets (Canada and Emerging Markets) capable of going slightly higher. Trade-, political- and geopolitical-related volatility is to be expected, with uncertain outcomes requiring a meaningful allocation to fixed income as a safe-haven investment.
  • Within equities, we recommend broad, diversified geographic and sector allocations. We recommend neutral exposure to Canadian, U.S. and International (EAFE) equities and an underweight to Emerging Markets.
  • For fixed-income investors, we recommend a neutral weight to sovereign bonds, offset by an overweight to investment-grade corporate bonds and underweight in high-yield bonds. Overall, we forecast a 1.5% total Canadian fixed-income return for the next twelve months. Importantly, fixed income remains positioned to deliver on its role as a risk-mitigation tool during bouts of risk-off sentiment or an outright deteriorating macro-economic environment.

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Copyright 2019 GLC. You may not reproduce, distribute, or otherwise use any of this article without the prior written consent of GLC Asset Management Group Ltd. (GLC).

This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.