Half full or half empty? 

Investment Policy,  February 2020

Half full or half empty?

The turn of the year may have ushered in a new decade, but it has not brought about any alteration in the investment environment. From the global economic perspective, the glass remains half full, but no fuller than that. One positive aspect is the continuation of consumer spending growth on all continents. By contrast, the glass looks half empty where the dynamism of industrial activity is concerned. However, in the event of further geopolitical and trade conflict de-escalation, there is potential upside here. In 2020, the trend for the global economy – but also for the asset categories of equities, bonds, and commodities – will once again be primarily determined by geopolitical events, as we have already seen with the rise of tensions in the Middle East at the beginning of January. The low market volatility witnessed at the year-end is likely to increase. 

The economic environment for investment markets was overshadowed by geopolitical developments in 2019, and the change of year will alter nothing in this respect. While uncertainties in the area of trade policy are receding following the signing of a “Phase 1” agreement between the US and China, geopolitical tensions surrounding Iran are on the rise. However, analysis of the detail of the recent trade agreement show that America will continue to impose punitive tariffs on two-thirds of Chinese imports into the US. In addition, there is little substance behind the detail, hence the following observation by the US trade representative: “The agreement will work if China wants it to work.” After all, China has not signed up to any legally binding changes, but has instead been persuaded to make a number of declarations of intent, which allows it to stick to its strategic technology plans. Accordingly, it is only logical to expect the rivalry/conflict between these two superpowers to flare up again in the medium term. For the next few months, however, the market is hopeful that this agreement will lead to significant economic progress. We believe that anything more than a moderate recovery is unlikely, which is why excessive optimism would represent a risk in itself. 

The consensus of the analyst community at the start of the year is particularly optimistic, this time due to the signing of the “Phase 1” trade agreement by the US and China. In line with this mindset, almost all banks believe equities with higher betas (such as cyclicals and emerging markets) should be overweighted. The substantial gains made by equities in 2019 also testify to the predominance of optimism. Furthermore, the consensus of bank analysts for 2020 is for corporate earnings to grow by some 9%, and even by double-digit percentages in emerging markets. In 2019, however, equity markets only rose due to a huge increase in valuations; corporate earnings recorded virtually no noteworthy growth. In view of the widespread optimism over earnings developments, a sceptical stance would appear appropriate here. While it is true that bonds (as the obvious alternative) offer paltry returns at best, this asset category does have the merit of acting as a low-risk cushion in the event of a market correction. A balanced investment policy therefore appears to be the right call if the glass is half full – as that inevitably means it is also half empty.

The consensus for corporate earnings growth in 2020 looks very optimistic.

Gérard Piasko, Chief Investment Officer

Just as they were in 2018, the fixed income markets were overwhelmingly dominated by the stance of central banks in 2019. Bond investors suffered clear losses in 2018 due to interest rate increases and the tapering of bond purchases on the part of the ECB and Fed, whereas historically high gains were booked in 2019 following a 180-degree turn in interest rate policy. Following the rate cuts and the resumption of securities purchase programmes by the ECB and the Fed, we are envisaging yields trending sideways while at the same time exhibiting a fair amount of volatility. Why? Because central banks are currently sitting on the sidelines as they wait to see the effect of their monetary stimulus on the economy. In the event of a moderate recovery, investment-grade bonds are likely to be interesting. But if the economy were to recover very strongly, i.e. beyond the market’s expectations (though this is not our base scenario), high-yield and emerging market bonds could outperform the sovereign segment. By that time, however, there would soon be a risk of the market pricing in renewed rate hikes. 

Following the gains of the first three quarters, the US dollar relinquished ground in the final quarter of 2019. This consolidation of around 3% was partly a reaction to the historically inflated valuation of the dollar at the end of September, but it also reflected growing optimism over the global economy outside of the US. This optimism is based on the hope that both the emerging market and European economies can now perform more dynamically than the US economy following the “mini-deal” in the Sino-US trade conflict. To a considerable extent, this hope has already been priced in. Given the economic experiences of recent years, however, this hope should be viewed with a certain degree of scepticism. The beginning of a new decade does not herald the end of the US dollar's dominance or the US economy's superiority. We are therefore expecting the dollar to embark on a period of sideways movement following its recent consolidation, with markets waiting for clearer signals regarding economic developments in the Eurozone and the emerging markets. In phases of heightened geopolitical tension, particularly in the Middle East, investors should also expect to see intermittent rises in the value of the yen and Swiss franc. 

In the last issue of our Investment Policy, we predicted a significant rise in the volatility of commodities, particularly gold, as we believed the level of volatility anticipated by the market was too low. As tensions in the Middle East could now rise again following the confrontation between the US and Iran, gold should continue to play a “geopolitical diversification” role in portfolios. The recent fluctuations we have recently seen in the oil price have been fairly modest by historical standards. In previous situations of escalating tension in the Middle East, price surges of 40% or even 60% were recorded, but fluctuations nowadays are more likely to be in the range of 10-20%, or even less in the event of political de-escalation. The reason for this shift is the fact that the US is now a net exporter of crude oil, i.e. the world’s most important economy is much less dependent on oil from the Middle East. By contrast, the emerging markets in Europe remain dependent on Middle Eastern oil. This explains why their equity markets react more sensitively to problems in this region. 

Gérard Piasko

Gérard Piasko

Gérard Piasko is CIO and head of the investment committee of private bank Maerki Baumann & Co. AG. Before he was for many years CIO of Julius Baer, Sal. Oppenheim and Deutsche Bank.

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Editorial deadline: 23 January 2020

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