Amid global economic stagnation and rising political uncertainty in a low-yield world, investors should look beyond the comfort of conventional asset classes with a cautious, diversified approach for better risk-adjusted returns, says Aberdeen Standard Investments.
James McCann, Senior Global Economist at Aberdeen Standard Investments, highlights key themes that are set to influence the global economy and investment landscape in 2020:
Global Economic Stagnation But Not Recession
“Secular stagnation with low growth, weak inflation and low interest rates is likely to define global economy for the next five years. Going into 2020, rising policy and political uncertainty will continue to weigh on industrial, trade and investment activities. We have downgraded our global GDP growth forecasts for 2020 and 2021 to 3.1%, well below the post-crisis average. A recession could be avoided next year but the risks have clearly increased.”
Dovish Central Bank Policies Cushion Slowdown
“Significant monetary easing by central banks should support growth at low but positive levels. We expect the U.S. Federal Reserve’s last rate cut in this mini-cycle to come in the first half of 2020, and the European Central Bank to take further steps. We also expect further action by central banks in Australia, Canada, Brazil, China, India and Russia in the coming months, and more fiscal stimulus next year as politicians look again at their tax and spending programmes. Such measures should help cushion any market shocks.”
Political, Trade Risks Dampen Sentiment
“With the fractious Brexit process, rising protectionism and trade disputes across the globe, investors will need to be cognisant of heightened geopolitical risk and its fallout. Lingering political uncertainty will create persistent direct and sentiment-driven drags onglobaltrade, business investment and services. US-China trade tensions remain a key risk and we do not foresee a quick resolution. Korea and Taiwan are vulnerable to trade conflict centred on the technology sector; while the dispute between Japan and Korea will further disrupt the global tech supply chain.”
Traditional Assets Returns Under Threat
“We expect investment returns from traditional assets to be much lower than in the past. A significant amount of government bonds are already yielding negative. The late stage of the business cycle and the lack of room for corporate margin expansion suggest that equity returns will be below their long-term average. The classic rotation from equities to government bonds and investment grade credit will no longer be appropriate in this cycle.”
Structural Themes Create Long-Term Opportunities
“In the next decade, structural themes such as climate change and technological disruptions are set to shape markets. An increasingly important driver of long-term asset class returns will be environmental, social and governance (ESG) factors, including demographic shifts, governance trends and environmental risks. As innovative technologies such as 5G and artificial intelligence create new opportunities, the technology sector outlook may see significant improvement from the current low base over the long run.”
How should investors position themselves in this environment?
James McCann comments:
Diversifying Across Less Correlated Assets
“The current environment warrants a cautious and diversified approach beyond conventional equity-bond allocation. While emerging market (EM) and Japanese equities still look attractive, other alternative risk-adjusted expected returns will come from less familiar asset classes. For example, the long-term prospects for local currency EM sovereign debt is unusually strong, with projected yields of nearly 6%. We are also overweight US Treasury Inflation Protected Securities (TIPS) and the Yen as diversifiers when volatility picks up.”
Enhancing Returns From Alternative Assets
“For investors who are able to bear illiquidity risk, private market assets which are uncorrelated with equity volatility, such as private equity, private debt, infrastructure and real estate, offer diversification benefits to portfolios and significantly higher returns potential than public markets. We particularly favour infrastructure, the combination of relatively high yields and economically insensitive cash flows makes it a very attractive diversifier.”
Investing in ESG and Technology
“The longer-term opportunities lie in ESG, low-carbon energy transition and technological disruptions.Tackling climate change requires massive transformation in energy use across the power, industrial, transportation, real estate and farm sectors. Meeting the Paris Agreement’s goals requires doubling annual global investment in renewables to over $700 billion. This is why ESG considerations must be at the heart of all investment strategies. Moreover, the innovation of artificial intelligence will not only transform business practices but also the investment opportunity set, creating winners and losers across the economy.”
Kenneth Akintewe, Head of Asian Sovereign Debt at Aberdeen Standard Investments, comments:
“The focus on yield in a low rate environment often distracts investors from the even more compelling reasons for investing in emerging market debt (EMD). The fundamentals of emerging economies continue to improve, becoming ever more important drivers of the global economy. The collective size of the EM debt markets already makes it one of the largest investment universes, yet still underrepresented in global asset allocators’ portfolios.
“The sheer diversity of emerging economies and markets offers substantial potential for diversification and opportunities to find value. US dollar EM and Asian corporate debt have consistently displayed some of the best risk characteristics, frontier bond markets tend to be more idiosyncratic and retain tremendous value, while local currency markets encompass unique, yet sizeable, markets like China and India and currencies that are undervalued by historical standards. In an increasingly interconnected, low rate world, the asset class is expected to play a crucial role in generating solid risk-adjusted returns for investors.”