Macro outlook and tactical asset allocation
Global growth below trend and
The global economy is rapidly decelerating, and we expect all major regions and countries around the world to grow below their trend rate of economic growth over the next few quarters, and at least through the first half of 2020. For the past six months, our macro regime framework, “Dynamic Asset Allocation through the Business Cycle”, as indicated that the global business cycle is entering a contraction, defined as growth below trend and decelerating. Our proprietary leading economic indicators (LEIs) have fallen sharply across most regions (Figure 1). This weakness has been most pronounced in the manufacturing sector, with global business surveys and industrial orders sharply deteriorating, because of tensions and uncertainty in global trade policy. In addition, business investments and capital expenditure (capex) have stalled, thereby curbing long-term growth expectations.
Figure 1: Identifying macro
regimes across major regions and countries
The global economy is growing below trend as of September 2019 and still decelerating from Jan 2019 to Sept 2019
Will we see
a global recession in 2020? We think it’s unlikely, but we may experience a
recession in some parts of the world. In our opinion, Europe exhibits the
weakest cyclical dynamics, and currently runs the highest recession risks among
major economies. Given its high exposures to global trade risks, the
uncertainty over Brexit, and already negative interest rates, Europe has
limited room to offset economic shocks. While we believe that a large and
coordinated fiscal expansion would be an adequate response to private sector
weakness, such a policy seems unlikely to occur before an actual recession. The
recent tightening in lending standards fully justifies the renewed European
Central Bank (ECB) asset purchase program, which may help avoid extreme
negative downside risk. That said, we are skeptical about whether the
asset purchase program can effectively boost the demand for credit in the
pond, the US has been the most resilient major economy, but we are starting to
see evidence that the global slowdown is affecting the world’s largest economy.
The current circumstances are similar to what we experienced between 2015 and 2016,
when the rest of the world led the slowdown, and the US followed. So far, the
US slowdown is mostly concentrated in the industrial sector, while
construction, housing activity, and consumer sentiment remained stable. Given the
US economy’s relatively lower exposure to trade risk and higher exposure to
domestic demand, we think the forecasts by some analysts of a recession in 2020
seem premature at this stage. However, the brief inversion of the yield curve
is a headwind to future credit growth, and we believe lending standards are one
of the key economic indicators to monitor going forward. Today, lending
standards still seem to be very accommodating but are not yet responding to the
prolonged flattening and instance of yield curve inversion (Figure 2).
Figure 2: Credit conditions respond to monetary policy with a lag
Lending standards tighten after prolonged periods of yield curve flattening and inversion
emerging markets (EM), we are seeing
tentative signs of stabilization in China after a steady deceleration over the
past two years, led by improving orders in the industrial sectors. Clearly, the
evolution of these cyclical indicators is strongly affected by ongoing trade
policy developments, but Chinese policymakers have been successfully managing
this economic transition, by and large. On the basis of our indicators, we
believe it is too soon to tell whether we are at an inflection point, as the
rest of the emerging markets ex-China are still decelerating across all EM
regions — Asia, Latin America, and EMEA (Europe, the Middle East, and Africa).
Policy and global
A distinguishing feature of this business cycle is the lack of inflationary pressures. This important development has allowed the US Federal Reserve (Fed) and the ECB to embark on proactive monetary policy easing in the face of slowing growth, with a combination of interest rate cuts and renewed asset purchases (effectively a Quantitative Easing program). The large decline in global bond yields has provided meaningful support to equity markets via lower discount rates and higher multiples, even while there has been a strong deceleration in earnings growth. Put another way, our analysis of market sentiment via global financial markets suggests that monetary policy has contributed to the stabilization in the global risk appetite after the steep decline in investors’ tolerance for risk that we experienced between April 2018 and June 2019 (Figure 3). As documented in our research, “Market Sentiment and the Business Cycle”, risk appetite tends to lead inflection points in the global business cycle by a few months. The stabilization of the risk appetite may, therefore, be providing an early sign that global growth may also stabilize over the next few quarters.
Figure 3: Risk appetite and the global business cycle
Based on our research detailed in the aforementioned whitepapers, the current global macro environment we’re forecasting has historically offered limited compensation for taking additional risk in the Invesco Oppenheimer Global Allocation Fund, with riskier asset classes such as equities and credit historically matching or underperforming safe assets such as government bonds. Indeed, the past two years have aligned with this pattern, as global equities have roughly matched global government bonds while our global Leading Economic Indicators and risk appetite indicators have signaled a slowdown.1 As we enter Q4 2019, we believe a moderately defensive asset allocation is still warranted while we wait for a more significant improvement in global risk appetite and stabilization in leading economic indicators to justify increasing risk in the portfolio.
a global 60% equity / 40% bond portfolio, we remain underweight equities by
about 10%, a position we have held through 2019, primarily expressed with an
underweight in developed markets outside the US. We maintain a moderate
overweight in US equities, with a factor tilt towards size and value, and an
underweight exposure to momentum. We hold a moderate underweight in US
equities, but with a pro-cyclical factor tilt towards size and value, and an
underweight exposure to momentum. For the first time in 12 months, we have
re-established a moderate overweight to emerging market equities, given
improving risk sentiment and early signs of recovery in the Asian cycle. We
remain overweight in alternative income assets, such as insurance-linked
securities and event-linked bonds, which tend to offer higher long-term
expected returns than core credit markets and favorable diversification
properties in the late stages of the credit cycle. We continue to overweight
duration in developed markets fixed income, a position we have held for the
past 18 months, but we have moved from a flattening bias to a steepening bias
in the US, where we expect additional rate cuts by the Fed should bring back
some steepness in the yield curve. Our overall currency exposure is neutral to
the benchmark, despite cheap valuations for major foreign currencies, and
expensive valuations for the US dollar. We think a cyclical rebound in growth
outside the US remains the primary missing catalyst for a sustained
depreciation cycle for the greenback. Such a cycle would require a major
reversal of private capital flows from the US to the rest of the world. Within
our neutral exposure to the US dollar, we are overweight cheap and high-yielding
emerging market currencies versus developed market currencies, a stance that has
the potential to enable us to harvest carry and valuation premia.
Figure 4: Global allocation portfolio
positioning as of October 16, 2019
the trailing 2-year period ending September 30, 2019, the MSCI ACWI (net)
returned 5.49% while the Bloomberg Barclays Global Aggregate Bond Index (USD
Hedged) returned 5.62%. Past performance is not a guarantee of future results.
An investment cannot be made directly in an index.
2. 60% MSCI ACWI & 40% The Bloomberg Barclays Global
Aggregate Bond Index (USD Hedged)
Blog Header Image: Denys Nevozhai / UnSplash
measures interest rate sensitivity. The
longer the duration, the greater the expected volatility as rates change.
MSCI ACWI Index is an unmanaged index considered representative of large- and
mid-cap stocks across developed and emerging markets. The index is computed
using the net return, which withholds applicable taxes for non-resident
Bloomberg Barclays Global Aggregate Bond Index is an unmanaged index considered representative of global
investment-grade, fixed-income markets.
The opinions expressed are those of Alessio de Longis as
of October 21, 2019, are based on current market conditions and are subject to
change without notice. These opinions may differ from those of other Invesco
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