December Thoughts from the Research Desk
December 20, 2019 | Simon A. Tryzna
As we head towards the end of 2019 and the end of the decade, I'm seeing a lot of different "Best of the Decade" articles reminding me of all the crazy, fun, and most surprising stuff that happened in the 2010s. As fun as it is to remember the good times and take a trip down memory lane, it's also interesting to see where we could possibly be going, especially in the capital markets. Over the past few weeks, I've been on calls, in meetings, and reading publications from close to a dozen different asset management firms (JP Morgan, Goldman Sachs, Blackrock, etc.) to get their short term outlooks and longer term capital market assumptions. The best way to think about and interpret these is that a lot of the risks and issues on investors’ minds are fairly easy to identify; the difficulty lies in figuring out the magnitude of said risks/issues and over what time frame they will develop. With that backdrop, here are some of issues, thoughts, ideas that were written and discussed (alongside my takeaways and thoughts), broken up into longer time horizons (5, 7, 10 years out) and short-term outlook (2020):
When developing capital market assumptions, strategists look to identify key issues that will affect economic numbers and then look to model them out over certain time frames. On aggregate, almost all of the firms I’ve gathered information from predict global equities to outperform fixed income, with emerging markets outperforming developed markets. The discrepancy lies in what issues and resolutions they expect. For the most part, there are two primary issues that are on the horizon: global growth and geopolitical risks. Additional issues tend to be a byproduct of one of these two (and to an extent, these two are closely intertwined).
Geopolitical risks have been a big talking point this year and in recent years, and rightfully so. The markets have been swayed by simple tweets by President Trump, and business leaders are anxious about the coming elections. One of the points I've been making in client meetings is that supply chain logistics have been affected, and with an increase in the populist movement globally (Yellow Vests in France, Five Star Movement in Italy, Brexit, etc.) and the turmoil in Hong Kong, a complete recalibration of the global supply chain could very well be necessary as trade deals get reworked. And while at the current moment the possibility of a resolution in the U.S. - China trade war is priced into the markets, the battle around intellectual property protection will continue to be fought in the years to come. The outcome of that will be felt by both economies, and could spill over into other emerging market nations. That said, emerging markets are still favored long term by strategists because of their overarching demographics. When talking and writing about global growth, the lack of young labor supply (due to aging populations) is a big risk in developed markets. Improvements in tech will help in job automation (consulting firm McKinsey & Company estimates that 40% of all workers are in industries that will lose jobs to automation by 2030) but have the ability to further increase inequality. It's not far-fetched to make a comparison that the increase in wealth inequality is a big driver of the populist movement across the globe, which in turn is leading to economic inefficiencies worldwide as global trade is disrupted and drags down global PMI numbers.
The overarching question to then keep an eye out for in the upcoming decade: are these problems structural and if so, what needs to happen in order to fix them? Is this a paradigm shift and what does that mean for investors? Lower real rates of return (when compared to historical norms) are very much a possibility as are any unforeseen risks that are a byproduct of the identified issues.
In the short term, the consensus is that we'll see slower global growth, but growth nonetheless. We were tracking on the way to a recession as global manufacturing contracted and the U.S. yield curve inverted. However, central bank easing, de-escalation of the trade war, and tentative green shoots in global PMI has eased those concerns. Most of 2019's gains are attributed to waning policy risks or evidence that the U.S. economy will avoid a recession for the time being. As a result, investors at the moment hold a more expensive-looking mix of asset classes. Equity returns are predicted to come from earnings growth, rather than multiple expansion (a by-product of the risk-on trade, where investors were paying higher prices today more for future growth).
Similar to long-term issues, the see the big risks for 2020 as geopolitical and global growth oriented. The consensus base case right now is that the combination of monetary and fiscal policy globally will help extend the cycle further; any deviations from that or others risks will increase the volatility in the capital markets.
In conclusion - the risks and expectations presented weren't eye opening for me; rather, they are a continual reminder of things to keep an eye on when evaluating headline news and having conversations with fund managers. Instead of focusing on the day's big news of what's driving the stock market, we have to ask ourselves if this is a quick short term issue or if this is a symptom of a broader issue, one that could have broader long term repercussions.
As a side note - one area that surprisingly wasn't covered too much, but I brought up in last month's note that I want to do a deeper dive into is the possibility of a debt crisis. As investors globally chase yield (fun fact - close to 26% of bonds in the world are trading at negative interest rates), a lot of money has flowed into High Yield (junk) bonds. As we have our semi-annual strategy review meetings, I'll be compiling their thoughts on it and making it into a separate post in the new year.