Recession fears open up opportunities for investors
Joseph Little, Global Chief Strategist, HSBC Global Asset Management, shares his investment outlook for the remainder of 2019.
So far in 2019 investment returns have been strong across the board. Fixed income asset classes are up around 10 per cent, and equity markets and alternatives have done even better. But, it hasn’t felt like a bull market environment for investors – in fact, it’s felt like the opposite.
As yield curves invert and a third of global bonds trade on negative interest rates, the signals look ominous. A ‘storm of uncertainty’ has developed, brewing from cyclical weakness in manufacturing, political uncertainty and a lack of ammunition from policy makers. As investors, we need to look at ways to navigate and ride out this storm.
However, it’s important to understand not just how the macro environment is evolving, but also what is being discounted by the market. Looking forward, our baseline macro scenario is not particularly optimistic, it is one of rather subdued growth, little inflation and ‘lower for even longer’ interest rates. But against that, the market is already betting on a recession, assuming policy will be ineffective and pricing a profits collapse.
We believe we are in the cyclical slowdown phase of the economic cycle – growth and profits are coming under pressure, but are not yet compromised. Global labour markets and services sectors remain firm. It is a bull market in pessimism and our cautious macro outlook is relatively optimistic. A pro-risk, but conservative investment strategy for investors, makes sense.
As the valuation gap between bonds and equities remains wide, there is upside potential we want to capture, but we are careful in not overextending risk given market uncertainties. Political concerns and recession fears have capped the upside in global equities in which we are overweight.
Although US growth is off its 2018 highs, it is still running at a solid pace compared to the rest of the world. The consumer remains in good health and its spending is the mainstay of US growth and arguably dragging a lacklustre global economy along with it.
We expect the US economy to slow, but our base case is that modest inflation and uncomfortably low inflation expectations mean the Fed is willing and able to ease policy further. This we hope will prevent US growth dropping significantly below trend.
We think the market may be pricing the average of two binary scenarios. One in which the economy continues to grow at a reasonable pace and one where downside risks materialise, and the Fed needs to cut aggressively.
China has seen some modest signs of improvement and previous policy easing measures should continue to support growth. If macro conditions were to weaken again, the authorities could also step in to stabilise the situation. However, we view the policy strategy as being more about risk management, rather than aiming to generate a strong cyclical upswing.
Wider emerging market (EM) growth also shows some signs of stabilisation, or at least a slower pace of deterioration. EM equities are relatively attractively priced and could outperform if key macro and political risks don’t materialise. This seems to be linked to the macro developments in China, the significant reduction in US bond yields during 2019, as well as cuts in domestic EM policy rates.
At present, we are overweight Asia credit. The prospective risk-adjusted returns continue to look attractive in Asia high yield and we think investors can be well-rewarded for those risks.
The Eurozone is the underperformer among the major economies, on the back of weak industrial and trade data. Germany in particular is at risk of a technical recession. Although a smaller exposure to the global manufacturing cycle and the auto sector has allowed some Eurozone economies to have held up better than Germany.
We continue to measure a very negative risk premium in European bonds. Investors are heavily penalised for taking duration risk in Europe, even given negative interest rates.
As Draghi announced a restart to QE last month, we think the policies aimed at the banking sector are an important innovation. If the ECB can deliver a little bit more monetary easing and simultaneously reduce the cost of equity for the banking sector, then the odds-on policy success increase materially. However, even then, modest growth and a slow increase in price pressures is probably the best that can be expected for the time being.