(Trust Net) There is likely to be a “favorable backdrop” for risk assets in 2020, according to an outlook by BlackRock, but investors need to be mindful that unexpected risks could emerge.
In the BlackRock Investment Institute’s 2020 Global Outlook, the investment house – which is the world’s largest with assets under management of $6.84 trillion – is taking a modestly pro-risk stance for the coming year.
The outlook argued that the 2020 macro environment will have undergone “a big shift” from the dynamics seen last year, when central banks performed “an unusual late-cycle dovish turn” to offset the effects of global trade tensions.
“Growth should edge higher in 2020, limiting recession risks. This is a favorable backdrop for risk assets,” the BlackRock Investment Institute said. “But the dovish central bank pivot that drove markets in 2019 is largely behind us. Inflation risks look underappreciated, and the lull in US-China trade tensions could end.”
Against this backdrop, the asset management house has introduced three new investment themes that it will be watching in 2020.
The first is ‘growth edges up’, which is based on the belief that the easier financial conditions created by central banks’ dovish turn in 2019 will lead to “an inflection point” in global economic growth.
The impact of such easing on the real economy tends to come with a lag – which has been particularly delayed this time due to the US-China trade war. This is illustrated in the chart below: the yellow line shows where the consensus GDP forecast may stand in three months’ time while the orange line is where we would expect growth estimates implied by financial conditions to be.
“We see a shallow growth pickup that pushes the economy back to the late-cycle norm of trend-like expansion,” the outlook said. “Yet easy financial conditions are unlikely to fully translate into stronger growth, partly because of the offsetting force of protectionism.”
BlackRock’s strategists believe that both the US and China have incentives to pause their trade conflict in 2020, as suggested by recent progress in relations between the two countries. Easing trade pressures between the US and China would provide “breathing space” for global trade activity.
They also expect higher average growth in Europe and emerging markets as they recover from a weak 2019. Meanwhile, they see the rebound as likely being led by the manufacturing sector (notably cars, capital goods and semiconductors), as well as interest rate-sensitive sectors such as housing and business investment.
“In sum, the expected growth pickup underpins our moderately pro-risk stance. And the firming that we expect to see in global industrial production and trade can pave the way for cyclical assets to outperform on a tactical basis, particularly those with beaten-down valuations,” BlackRock said.
“This supports our call for modestly overweight positions in regions and companies dependent on global trade, such as Japanese and emerging market equities. Easy monetary policy in the emerging market world supports this view.”
However, the biggest risk to this theme is that the US-China trade talks break down or protectionist pressures broaden out, which would under business confidence and market sentiment while ending a growth uptick.
BlackRock Investment Institute’s second theme is called ‘policy pause’ and is based around the idea that there will be less scope for monetary easing and other policy surprises in 2020 and markets are therefore likely to be driven by economic fundamentals.
The investment strategists doubt that the Federal Reserve will further ease its policy stance and although the European Central Bank and the Bank of Japan may consider more monetary easing next year, both have limited policy space left to play with.
“The main point: we see little scope for the type of unexpected dovish pivot that drove markets in 2019. Instead, monetary policy looks set to stay easy across the US, euro area and Japan, with rates below equilibrium levels. The lagged effect of policy easing should start to filter through to economic activity,” they said.
“Easy monetary policy, low rates and low bond yields offer a favorable backdrop for income-generating assets, in our view. We see room for many emerging market central banks to ease, supporting emerging market growth. This underpins our overweights in emerging market debt, particularly local-currency, and in high yield.”
Next year will likely see the policy debate switch from monetary stimulus to fiscal measures, although it doesn’t expect the US to embark on this next year – and believes fiscal policy there might even become less easy. Instead, any fiscal stimulus in 2020 is more likely to come from Europe, Japan or emerging markets other than China.
The final theme that BlackRock is keeping an eye on in 2020 is ‘rethinking resilience’. This says that US Treasuries can maintain their role in defending portfolios against equity market sell-offs but suggests investors rethink how effective other government bonds will be doing this.
“Monetary policy may be reaching its limit in stoking growth — and rates in some developed markets are nearing the lowest levels that central banks can feasibly set. The pool of sovereign bonds with negative yields expanded to some $17 trillion in 2019, according to Bloomberg data,” the BlackRock Investment Institute said.
“As bond yields fall closer to lower limits, the risk/return profile for bonds becomes increasingly asymmetric. In other words, bond prices have more room to fall than rise in response to shocks. The cushion that government bonds provide against equity market drawdowns gets thinner as yields decline. These limitations are most acute in Europe and Japan, where negative yields abound.”
As part of the ‘rethinking resilience’ theme, the asset manager has upgraded its view of the quality style factor. Its strategists argued that companies with quality characteristics such as strong balance sheets tend to be more resilient to late-cycle risks, while many large multinationals in this category could benefit from a pause in trade tensions.