River FOURcast: February 2020
Welcome to our monthly macro update, giving greater insight into our outlook for investment markets and the investment ideas that currently interest us. We take a dynamic approach to investing assets: adapting our clients’ portfolios to the prevailing market conditions to manage risk and take advantage of opportunities to earn return. It’s a proven process, and we have a successful 15-year track record of applying it.
We make our internal views accessible using our four phase framework, the River FOURcast. Much like a weather forecast, it provides a guide to what we think may be coming, and how we should be positioning portfolios to prepare for the climate to come.
- It was a challenging month for return seeking assets, despite a strong start, with most global equity markets ending in negative territory. The US was the only notable exception.
- Markets experienced a pull-back in late January, as concerns about the impact of COVID-19 (a type of novel coronavirus) seem to have provided enough of a reason for overextended and expensive markets to fall. Sustained market rallies often take a temporary pause, and we see this as no exception.
- Economic expectations showed some signs of improvement, with data from the US and Germany surprising to the upside.
- Our outlook for 2020 remains positive, with the easing in financial conditions that we saw over 2019 providing a tailwind for markets. This Stable backdrop is supported by reasonable valuations in certain areas, strong credit conditions and improving economic expectations.
We believe we are still in the Stable phase of the market, although recognize that short term volatility is likely to occur after such a strong run in markets.
- Credit conditions remain strong, with low credit spreads and government bond yields continuing to support borrowing. This tends to be a short-term driver of markets, but we expect this to remain supportive through the first half of 2020.
- We believe economic expectations have reached a turning point. We always expected a delay between stimulus and improving expectations, but we believe this has now started to happen. We expect economic conditions to improve over 2020, providing a good backdrop for return seeking assets and equity markets.
- Global equity valuations in general range from reasonable to expensive depending on the market. US large cap equities remain expensive, but for now they remain supported by low bond yields and what we believe to be an improving economic backdrop.
To recap, Stable does not mean a complete lack of volatility as there are always headlines that could spook markets. But the fundamental backdrop is positive, and we believe that markets will trend strongly upwards into 2020.
COVID-19 Spreads Globally
A novel coronavirus, similar in form to the SARS and MERS viruses, emerged from the Chinese city of Wuhan, has infected tens of thousands of people and killed over 1,000 as of mid-February. Equity markets started to react negatively in the latter half of January as investors learned of the virus’ global spread and questioned the potential impact on the Chinese economy and the wider global economy. The World Health Organization has declared the outbreak a global health emergency.
Many have been quick to draw comparisons to previous global health scares, including SARS. While it is worth remembering that China was a much smaller share of the global economy in 2003 when the SARS outbreak occurred, in such cases global market losses have typically been limited and have been recovered quickly. The outbreak could certainly pose a short-term risk to Chinese growth, but if it can be contained quickly, we should see a rebound, as was the case during the SARS outbreak. In fact, China is providing significant financial stimulus in a bid to mitigate some of the economic impact, which might be positive for growth overall.
More Signs of a Global Economic Recovery
A global economic pickup does appear now to be unfolding, albeit slowly and notwithstanding the headwinds discussed above. In the US, data surprised on the upside, with economic expectations in the services sector showing the highest rate of expansion since last March. Data also showed that Germany’s services sector gained momentum, with activity in January growing at the fastest pace in five months; even the troubled manufacturing sector showed some improvement.
With earnings season underway, signs are equally positive. Analysts had been expecting a decline in fourth quarter earnings, but in aggregate companies have posted stronger than expected results. Although only around half of companies have reported so far, all US sectors are on average beating expectations.
Implications For Portfolios
We continue to believe conditions are supportive for return seeking assets over the next 12-18 months, however we recognize that markets can rally quickly and become overheated. We believe overweight risk positions should be maintained, but in areas where valuations are less stretched, particularly in more cyclical equity markets such as developed ex-US, value and small cap.
Our Recent FOURcasts
2019 turned out to be a fruitful year for equities with the S&P500 achieving record highs and delivering more than a 28% return for the year. However, 2019 returns were boosted by a low starting point at the beginning of the year following the 2018 “Christmas Crunch”.
We believe we are in the Stable phase of the market; we saw reduced equity volatility in November compared to the past few months, but the lower liquidity around the Christmas period could lead to a return of some volatility.