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Major Themes For 2020
Equities: A Growth Tilt
Equities performed strongly in 2019 and an absence of trade shocks in 2020 could reinforce confidence in world economic expansion. Citibank analysts are calling an overweight in global equities, with a 12-month forecast of 6 to 8 per cent in total returns, underpinned in particular by high quality dividend growth.
Growth stocks typically outperform in late-cycle bull markets, and hence, Citi analysts retain a growth tilt with a preference for technology and healthcare. Energy is also a favoured value sector.
There are a number of reasons for optimism. One, there is little sign at the moment of "near-euphoric" risk sentiment - defined as strong returns and inflows into risky assets - which typically marks a peak in the bull cycle. A closer look at monthly return and fund flows relative to prior bull market peaks shows neither a runaway rally nor a long-global equities appetite from retail and institutional investors.
Two, Citi analysts expect a strong global industrial sector rebound in 2020, supported by a resilient consumer. In the absence of a new, larger trade tension shock, a snapback in manufacturing and trade activity could materialise. Cyclical industries’ profits are expected to rebound, and global earnings per share are forecast to grow 7 per cent in 2020, compared to a weak showing in 2019. Three, monetary policy turned supportive for risk assets in 2019, and many central banks followed the Fed’s easing footsteps.
Four, valuations are still "not quite" frothy, say Citi analysts. The MSCI AC World benchmark is trading on a trailing price earnings multiple of 18 times, slightly above its long term median of 17 times. The US market looks the most expensive while EM, UK and Japan offer the best value. ”Although absolute valuations may not look particularly compelling, equities still provide good value compared to fixed income," say Citi analysts. Global dividend equities yield an average 2.5 per cent while global bonds yield just 0.6 per cent. In all major DM economies, equities are yielding more than bonds.
Eastspring Investments holds out a scenario of continued economic recovery as there is little evidence of a classic over-investment bust or recession. "The recovery will be good for equities which are more attractively priced than bonds. It will also be positive for corporate earnings, particularly in Asia, which have borne the brunt of the trade slowdown. We note that the trend of earnings revisions globally is improving. More aggressive fiscal policy, if it materialises, would also boost equities."
Citi expects earnings growth of 5 per cent for European equities, lower than the consensus estimate of 10 per cent. This suggests earnings downgrades may be in store. Still, on a valuation basis, European equities appear "modestly cheap on an absolute basis", and even more so relative to government and corporate bonds.
EM Asia is expected to generate the strongest potential returns. Chinese equities, for instance, are trading at 12.3 times forward PE, the lowest in Asia, with earnings growth expected to rebound from a low base in 2H19. Chinese equities have significantly underperformed DM equities, and a trade ceasefire between the US and China could help to narrow the gap. Chinese equities are also set to benefit from an increased weightage in international benchmark indices.
Bonds: Hunt For Yield
With the downward trend in interest rates, the global hunt for yield is likely to persist. In 2019, more than 30 central banks cut interest rates, and core non-US rates are near historical lows.
In the US, the Federal Reserve lowered policy rates by 75 basis points between July and October last year. Citi analysts expect no further easing in 2020 from them, in the absence of any likely overshoot in inflation targets.
The Bank of England is expected to cut rates by 25 basis points. The Reserve Bank of Australia is also expected to further ease policy rates.
In 2019 global aggregate benchmarks gained over 8 per cent as bond yields fell and credit spreads tightened. Investment grade corporates, high yield (HY) bonds and other long duration high quality assets generated equity-like returns. "While pleasing, this now leaves investors at a perplexing crossroads. Yields were already low at the beginning of 2019, and now that proposition has worsened," say Citi analysts. Currently global benchmark yields including HY and EM debt hover at around 1.6 per cent, just 20 basis points above historical lows. Global credit spreads also tightened near an 18-month low.
Citi analysts’ preference is for longer duration bond exposures, particularly in US investment grade corporates. US dollar-denominated EM debt offers some of the best relative value but a globally diversified approach is prudent given the region’s volatility. Asia HY bonds have lagged their US counterparts due to trade tensions and rising default rates. But Citi analysts see scope for spread narrowing, particularly in the Chinese property sector.
Commodities: A Bear Case For Oil, But Gold Shines
Despite the recent developments between Iran and US inherently putting short-term upward pressure on oil prices, the outlook for oil still looks bearish in 2020, thanks to the uncertain macro outlook and strong supply growth from the US, Brazil, Norway and new oil province, Guyana. Oil prices rose strongly by US$10/bbl in 2019, as the September attack on Saudi Arabia oil facilities caused one of the most severe supply disruptions. But prices subsequently gave up most of their gains on signs that Saudi supply can quickly recover.
Citi analysts expect average Brent and WTI prices of US$64/bbl and US$61/bbl respectively in 2020.
Gold, on the other hand, is expected to trade strongly for a longer period, possibly breaching US$2000/oz and posting all-time highs at some point in the current cycle. Citi analysts cite a number of factors as positives for gold: lower for longer interest rates, global trade tensions, heightened geopolitical risks and uncertainty over 2020 US elections. Demand factors such as record central bank and investor buying activity also underpin a bullish gold outlook in the medium term.
The downside risk is that a surprise completion of a US-China trade deal (not a base case for Citi) and a sharp upturn in global manufacturing data could see gold stay low at US$1400-US$1500/oz.
US Dollar: Still King?
The US dollar is traditionally seen as a safe haven currency but the major uncertainties in this cycle - mostly relating to the US - could upend that status.
In the US, impeachment proceedings against Trump could pose a significant hurdle to Trump’s domestic economic agenda and re-election. On trade, phases two and three of US-China trade agreement represent more difficult issues and may drag past the November 2020 presidential elections, morphing into more serious US-China political tensions. On the economy, Citi analysts’ base case is a more moderate pace of growth with no further Fed rate cuts. Still, rate cuts are more likely than hikes and the US yield curve recession signals still suggest a hard landing.
If the US dollar loses its safe haven status, the Japanese yen and gold are likely beneficiaries, say Citi analysts. JPY typically outperforms the G10 and EM FX complex as a safe haven during times of heightened uncertainty. In 2020, the yen is expected to find support thanks to a more positive backdrop, such as a slower pace of the Bank of Japan balance sheet expansion.