2020 Market Outlook

Risk radar

Despite the uncertain investment climate, investors should avoid being overly pessimistic. Being under-invested can mean missing out on attractive returns while extrapolating short-term trends can prove costly as one tends to overlook the true fundamentals.

The US Federal Reserve (“Fed”) had been on a gradual rate hiking mode between December 2015 and December 2018. But early 2019, the Fed abruptly announced an end to its 3-year rate hike cycle, citing signs of an economic slowdown and ongoing risks including Brexit and the US-China trade hostilities. The Fed has since followed through with this “dovish” stance by cutting rates three times.

The Fed’s rate cuts have been mirrored by central banks across the globe. Many have announced larger-than-expected cuts, firmly entrenching the trend of global monetary easing. Central banks are still concerned about economic growth and will continue to do whatever it takes avoid a sharp slowdown. Asian central banks are generally willing and (more importantly) able to cut rates to support growth (refer to the interview with our CIO of Fixed Income, Low Guan Yi).

The current weak global growth has also resulted in inflation consistently undershooting central banks’ inflation targets. Lack of inflationary pressures will make central banks more inclined to ease further.

Although the Fed has signalled that it may pause to evaluate new data before adjusting rates again, markets are pricing in more rate cuts this year and next. When such policy expectations are high, the risk for disappointment is also high.

Against this backdrop, a less-than-expected dovish monetary policy stance, due to central banks falling behind the curve, could potentially push bond yields higher. In negative-yielding markets, such as the Eurozone and Japan, the perceived limitations for policy manoeuvre could also threaten the stability of bond markets.

Ride these uncertainties by staying nimble and adjusting duration positions actively (refer to the interview with our Head of Investment Solutions, Kelvin Blacklock).

Monetary policy space has narrowed1

1Bloomberg and Nomura. The policy rate for Singapore refers to 3-month SIBOR and for China refers to 7-ay reverse-repo rate. Please refer to www.eastspring.com/reference-index-list for more details on the indices.

To recap, recession talks emerged in late 2018 which subsequently faded early 2019 only to resurface in the third quarter when yields on short-term US bonds rose higher than those of long-term bonds. This phenomenon known as the inverted yield curve is typically taken as a sign of a contracting economy and historically has preceded every recession in the past 50 years.

Stock markets have rallied and sold off (both times sharply) as these fears ebbed and flowed. Investors who have avoided equities over concerns of an impending recession would have lost out on some spectacular returns. The S&P 500, for example, set another record high at the start of November 2019 on better-than-expected US jobs data. Over in Asia, stock markets have also recorded robust returns year-to-date as evidenced by the chart.

Our investment teams are of the view that the while global growth is expected to remain lacklustre, a global recession is still not their base case scenario taking in the view the likely policy support and varied strands of domestic resilience (refer to the interview with our Head of Investment Solutions, Kelvin Blacklock). US economic data while moderating is still decent, and the strong labour market continues to support consumer spending. The US economy should also continue to enjoy support from easy financial conditions and buoyant asset markets.

With expectations on the low end, upside surprises in growth data could again trigger a rally as will the resolution of the US-China trade tensions. Staying on the side lines could prove costly but not without due diligence.

Best to go back to basics – rely on fundamentals and be selective when choosing equity investments (refer to the interview with our CIO of Equities, Kevin Gibson).

Equities have chalked up attractive returns in 20191

1MSCI Ac Asia Ex Jp, MSCI EM Europe, MSCI EM Asia, MSCI India, MSCI USA, MSCI Japan, MSCI EMU, MSCI China, MSCI EM Latin America, MSCI World Value, MSCI World Growth, MSCI AC Asia Ex Jp Growth, MSCI AC Asia Ex Jp Value, MSCI Thailand, MSCI Philippines, MSCI Singapore, MSCI Malaysia, MSCI Korea, MSCI Indonesia as at 31 Oct 2019 from Refinitiv Datastream. Please refer to www.eastspring.com/reference-index-list for more details on the indices.

Short termism may be defined as the tendency to make decisions in search of immediate gratification at the expense of future returns. Investor who are focused on very short-term financial timeframes are likely to use the latest profit numbers to forecast the future earnings of a company or market. That said, it is not surprising to observe this type of short-term behaviour as a response to the uncertain environment.

The risk of adopting this approach, however, is to completely overlook the fundamentals. Some companies may face short-term earnings challenges but are undergoing structural improvements which are typically observable over a longer-term timeframe. Conversely companies that report high earnings delivery in the near-term may not have a sustainable long-term business model. Paying a high price for companies with high earnings delivery and growth expectations makes investors susceptible to earnings weakness and shifts in risk sentiment.

Equities historically have produced more stable returns over the long-term. Over shorter periods, however, equity returns can fluctuate significantly as seen in the chart. If one held Asia Pacific ex Japan equities for only one year, between 1988 and 2019, the returns varied from -57% to +89.3%. If the holding period was extended, the range of returns narrowed; over 10 years, the range was -0.60% to +16.0% per annum. With longer holding periods, volatility decreased and returns stabilised in the positive range (refer to the interview with our CIO of Quantitative Strategies, Ben Dunn).

A short-term time frame leaves one vulnerable to sudden swings in risk sentiment which can trigger a market rally or sell-off. Increasing investment horizons and focusing on companies’ long-term sustainable earnings allow investors to relate longer-term returns to the true value of the company and place less emphasis on short-term earnings delivery (refer to the interview with our CIO of Equities, Kevin Gibson).

Performance diverges significantly in the shorter holding period1

1MSCI AC Asia Pacific ex Japan, Gross Returns (USD), data as of 31 Oct 2019 from Bloomberg. Starting periods vary - 1 year (31 Dec 1988), 3 years (31 Dec 1990), 10 years (31 Dec 1997). Please refer to www.eastspring.com/reference-index-list for more details on the indices.