Two dueling forces have shaped asset performance in 2019: the protectionist push and a dovish pivot in monetary policy. The latter won out for risk assets, fueling multiple expansion in equities and helping send bond yields to historic lows. What do we expect in 2020? The three new themes we introduce in our 2020 Global outlook point to a big change in market drivers, with an expected manufacturing-led growth uptick painting a better backdrop for cyclical assets.
This year’s major market drivers appear to be behind us. We see less room in 2020 for dovish monetary policy surprises, and the U.S. and China have strong incentives to hit pause on their trade conflict across 2020, though there may be turbulence along the way. We see growth now taking the reins as the driver of risk asset returns. Our base case is for a mild growth pickup as easier financial conditions start filtering through and sideways protectionist pressures give global trade activity some breathing room (our “growth edges up” theme). We see this backdrop — coupled with what appear to be reasonable valuations across equities and credit — paving the way for modest returns in global risk assets. Our estimate of the equity risk premium (ERP) — or the expected return of equities over the risk-free rate — shows that the ERP still looks relatively attractive in a long-term context, as evident in the chart above. This supports our modest tilt into risk for 2020.
The case for cyclicals
We have moved to a moderately more cyclical posture, from the more defensive one we took in our midyear 2019 outlook. Cyclical assets have severely underperformed in recent years. We believe a firming in global trade and capex should pave the way for stronger performance of cyclical assets, such as Japanese stocks, emerging market (EM) assets and high yield bonds, over a 6-12 month tactical horizon.
Japanese and EM equities are among those set to benefit most from a global manufacturing recovery and a lull in U.S.-China trade tensions, in our view. And EM central banks outside of China are likely to stay on their easing paths, supporting growth and equity markets. From a factor perspective, we have upgraded quality because companies in that basket tend to be more resilient to late-cycle risks and should benefit from a pause in trade tensions. We see U.S. stocks performing more in line with global equities in 2020 after their long stretch of outperformance, as rising political uncertainty in a presidential election year may weigh on sentiment.
Our bond views
Changes to our fixed income views come amid less scope for monetary easing surprises or fiscal stimulus (our “policy pause” theme). Major central banks appear intent on maintaining easy policies – and interest rates and bond yields look likely to linger near lows. With income crucial in a slow-growth, low-rate world, we favor EM and high yield debt. We have downgraded global investment grade credit, as low coupon rates make the sector’s income relatively unattractive on a risk-adjusted basis.
At the same time, yields testing lower limits in developed markets and underappreciated inflation risks call for a rethink of the role of bonds as portfolio ballast (our “rethinking resilience” theme). We favor shorter maturity U.S. Treasuries to lower-yielding developed market peers and also like inflation-protected securities. Both can also potentially provide cushion against risks to growth, such as a breakdown in U.S.-China trade talks. Finally, we believe a focus on sustainability can help add resilience to portfolios as markets wake up to environmental, social and governance (ESG) risks. Read more on our updated asset class views in our 2020 Global outlook and our Weekly commentary.
Mike Pyle, CFA, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy function within the BlackRock Investment Institute. He is a regular contributor to The Blog.