River FOURcast: January 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.
- 2019 was a strong year for markets, however annual returns overall were bolstered by a low starting point after a weak end to 2018.
- In December, a “phase one” deal was agreed between the US and China, which rolled back some planned US tariffs in return for trade concessions from China, lifting markets.
- However, there are ongoing geopolitical concerns for the market, and a comprehensive trade deal is far from being finalized, therefore volatility around headlines can still be expected.
- Our outlook for 2020 is strong, with a Stable backdrop continuing, supported by reasonable valuations, strong credit conditions and economic expectations improving.
- The easing we saw in 2019 from central banks and falling bond yields are additional tailwinds for markets so we are optimistic about returns in 2020.
2019 turned out to be a fruitful year for equities with the S&P500 achieving record highs and delivering more than a 30% 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 still in the Stable phase of the market framework:
- Despite the strong returns we’ve seen, global equity valuations remain reasonably fair with only the US looking expensive. US Equities continue to be a strong performer and perhaps there is good reason for current valuation levels given the low interest rate environment.
- Credit conditions are very strong, improving during the last few weeks of the year as corporate bond yields fell further. This indicates positive sentiment from markets and is a particularly good predictor of short-term returns, meaning the start of 2020 should be strong.
- Our forward-looking view of economic expectations continues to improve and purchasing managers’ indices (PMIs), which are good predictors of economic growth, are moving into positive territory. Some growth measures are still a little negative, but overall there is a good backdrop for equity markets as economic expectations improve.
The Stable market phase does not imply a complete lack of volatility as there are always events that can spook markets. But the fundamental backdrop is positive, and we believe that markets will trend upwards into 2020.
Trade Between the US and China
The US and China have announced a deal that suspends and rolls back some of the US tariffs in return for a few concessions from China. By all reports, it’s a fairly lackluster “phase one” deal but markets have taken it positively. The impact of this deal, however, is not enough to boost economic growth significantly, and leaves much uncertainty still on the table. The fundamental drivers of the trade war remain, and if Trump is re-elected in late 2020 it is likely a theme he will continue to pursue. How it plays out in the election campaign is yet to be seen.
The Bond Yield Roller-coaster
Bond yields hit new lows in the summer, falling dramatically after the Federal Reserve switched to policy easing and fears of slowing growth intensified. US treasuries fell to extreme lows, with the 10 year treasury yield falling from highs of 3.2% in late 2018 to below 1.5% in August 2019. Yields have since risen a little from these lows, but we believe as global growth picks up yields could rise back to similar levels they were at a year ago. That’s a potential 0.5-1% rise from their current levels.
Implications For Portfolios
We believe conditions are supportive for risk assets over the next 12-18 months and we will look for opportunities to increase exposure. In particular, cyclical sectors typical in value style investing are likely to do well. It is also likely that long-term interest rates will rise modestly, which could provide an opportunity for pension plans to extend their rate hedging programs.
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