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2020 ‒ Resilience and fragilities


INVESTMENT STRATEGY

JANUARY 2020

 

Laurent Denize

Laurent Denize,
GLOBAL CO-CIO &
GLOBAL HEAD OF FIXED INCOME

In relative terms, we prefer European stocks. Especially the unjustly left behind small caps from France still offer a lot of potential for re-valuation

If they had only the courage to invest, investors could hardly do anything wrong last year. All major asset classes rose. However, despite double-digit growth for almost all equity markets, equity funds recorded outflows in a politically turbulent market environment marked by declining growth. What lessons can be learned for 2020 from a 2019 that turned out better-than-expected?

Stabilization of growth: Last year, global economic growth stabilized at a level of around 3 percent. This is well below the 4 percent recorded in 2017, but also far from the recession feared in the market place. While the USA hardly suffered any growth losses in the years thereafter, the figures in the euro zone and especially in export- and car-dependent Ger-many were significantly worse. But here too, we do not ex-pect any further deterioration next year. Even if the tailwind of the stabilizing economy helps, investors will still have to live with a fragile market environment in 2020. Five issues stand out:

More uncertainty through protectionism: Donald Trump's trade war has increased trade costs through tariffs, but as expected it has failed to achieve its stated goal of reducing the foreign trade deficit. Despite the Phase 1 agreement at the end of the year, the US trade policy will remain erratic and try to contain China as an emerging Power thus affecting the investment climate worldwide in the coming years. 

Supportive monetary policy: In response to the heightened political uncertainty, the Fed initiated a monetary policy turnaround, which other central banks such as the ECB followed. After three interest rate cuts in 2019, the US central bank will probably hold back in the election year 2020. Despite an ultra-loose monetary policy inflation has remained low on both sides of the Atlantic. But due to both internal factors as rising wages and external ones as higher import prices we expect it to pick up sooner or later.

Domestic strength: While the export-dependent industrial sectors despite slight signs of recovery continue to suffer from the decline in global trade, the construction and services sectors are benefiting from low unemployment and low interest rates.

The situation in Germany: Germany's heavily export-dependent economic model is reaching its limits. It is questionable whether impulses for better EU integration or future-oriented investments will come from here.

Political fragmentation: A more fragmented political landscape is replacing the established two-party-systems. Populist parties will not necessarily benefit from this, although uncertainty is increasing here too.

  

Fixed income: With the tailwind from the ECB's purchasing programs and the flight to safety at any price, all segments of the bond market boomed in 2019. The potential for further gains in 2020 is therefore rather limited.  The supply of investment grade paper is scarce due to central bank purchases and inflows into bond funds, which should support prices. In the high-yield segment, credit defaults are expected to rise, although they are likely to remain low given the stable economy. We consider that there’s still value in investmentgrade paper. Tactically, in the high yield segment, we prefer B-rated bonds, as they have still a strong potential to catch up.

Equities: US equities are highly valued according to tradition-al criteria (such as Shiller-P/E). There is not much upside potential here anymore. In relative terms, we therefore prefer European stocks. Especially the unjustly left behind small caps from France still offer a lot of potential for re-valuation. 
Private equity: The private equity industry can also look back on a boom year. The trend towards withdrawal from the stock exchange will continue to support the segment in the coming year. In view of high valuations and expensive deals, howev-er, the secondary market offers a more attractive risk/opportunity profile. 

Private equity: The private equity industry can also look back on a boom year. The trend towards withdrawal from the stock exchange will continue to support the segment in the coming year. In view of high valuations and expensive deals, however, the secondary market offers a more attractive risk/opportunity profile.

New ways to invest - AI and sustainable investing: It is essential today to rethink the way we invest. 
Analyzing portfolios with artificial intelligence enables to anticipate the major trends of the coming years and identify the most promising companies.
When closely integrated into the investment process, the analysis of ESG criteria provides greater insights into companies and a finer analysis of risks not covered by a traditional approach (climate, reputational,…). Both trends will provide long term investors with tremendous investment opportunities in the coming years. 

In a nutshell: we prefer equities to bonds, Europe to the USA, and size (small caps) to momentum. What could derail our scenario is foremost: an unexpected pick-up of inflation with bond rates going up which would have consequences for the valuations of stocks. Geopolitical crises could flare up quickly with unforeseeable consequences. The world will be fragile, so our investment strategies must be flexible.

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