THE JAPANIFICATION OF THE GLOBAL ECONOMY
Global Macro & Market Outlook Fourth Quarter 2019 PARTNERSHIP CONTENTS
Global Macro & Market Outlook INVESTMENT CHOICE Introduction 2 The Key macro risks 6 PRUDENCE Summary of asset views 7 Developed Markets Outlook 10 US 10 Canada 14 London & Capital’s approach to investing Europe 16 UK 19 is the same as our approach to our clients. Emerging Markets (EM) 22 China 22 We listen and observe. We ensure we have India 24 a complete understanding and then invest The World at a Glance 26 accordingly to provide financial stability and Fixed Income 28 investment returns. No hunches, just learning Government bonds 28 Corporate investment grade bonds 31 from homework and history. Financials 34 Corporate high yield 36 EM IG and HY debt 37 Call us on +44 (0)207 396 3200 Equities 36 or visit londonandcapital.com Overview 36 Our positioning 38
Alternatives 42 Overview 42 Our positioning 45
FX 47
1 It is most evident in the astounding appetite for the safest of assets: government bonds. In Germany, where figures this week showed that the INTRODUCTION economy is shrinking, interest rates are negative all the way from overnight deposits to 30 year bonds!) Investors who buy and hold bonds to maturity On the back of the will make a guaranteed cash loss. In Switzerland negative yields extend screeching handbrake all the way to 50 year bonds. Even in indebted and crisis-prone Italy, a 10 year bond gets you only 1.5%. In America the curve is inverted (rates turn by major Central on 10 year bonds are lower than on 3 month bills), a rare occurrence that could be a harbinger of recession. Banks, financial Angst is evident elsewhere, too: Pau Morilla-Giner markets are showing - Over half of the world's bond Fear of a weaker Chief Investment markets are trading below Officer signs of extreme the Federal Reserve (Fed) global economy confusion: while funds rate. that turns equity markets still seems to be - Gold is at a six-year high. Copper prices, a proxy for in 'insurance policy' mode, bond industrial health, are recessionary down sharply. markets have moved to price in a amid an extended - Despite Iran’s seizure of oil higher likelihood of recession. tankers in the Gulf, oil prices trade shock is have sunk to $60 a barrel. - Organisation for Economic challenging the Co-operation and Development’s (OECD) idea that the composite of leading indicators fell in June for the 18th Fed is set for consecutive month (the longest stretch of weakness since the just a 'mid-cycle great recession). - China’s auto sales fell again adjustment to in July (the 5.3% year-on-year decline is the 13th negative policy' reading in the past 14 months).
2 3 The fear of a weaker global - Car sales fell 2.0% in July on The main danger is that of a economy that turns recessionary top of a 1.3% slump in June profit recession in the US. The We are heading amid an extended trade shock (and have now declined in three past decade has been great for is challenging the idea that the of the past four months). companies, with record profit for a prolonged Fed is set for just a “mid-cycle margins due to lower corporate - Existing home sales dropped adjustment to policy”. The latest tax rates, low cost of capital and 1.7% in June even with much stagnation, central bank action will also very moderate wage growth, the lower mortgage rates — they play a key role in expanding the issue now is not that margins fall have been flat or down in driven as much universe of negative-yielding debt, off a cliff (we will not have inflation three of the past four months, as investment mandates require all of a sudden), but that further and have declined by 11% at by political managers to buy government improvement in margins is off table an annual rate over this bonds. As yields fall, so managers and they are going one way: down. time frame. uncertainty buy more in order to stay balanced versus their respective fixed-income Conclusion: The private sector In Europe, the ECB was confronted as underlying benchmarks. This only expands the in the US has so much debt that with slowing economic growth, tide of negative-yielding debt, and lowering the cost of credit will not uncertain politics and wobbly fundamentals places downward pressure on other cause the kind of demand reaction markets, and so it reliably came global sovereigns with positive that historical standards suggest. to the rescue with new stimulus yields such as Australia, Canada measures and a deferral of the start and the US. to any normalisation of interest rates. A low-growth, low-inflation The coming Fed rate cuts will keep The main environment, along with a negative the economy ticking for a while, deposit rate and ample central but will do little to reactivate the danger is that bank liquidity, bears a striking economy and avoid the upcoming resemblance to post-bubble Japan. significant slowdown. Even before of a profit Long live QE! the Fed did a thing, the yield on the 10 year Notes fell by 1.30%, recession in To sum up, we are heading for a which helped drag down a gamut prolonged stagnation, driven as of borrowing costs priced off the the US much by political uncertainty as Treasury curve, but there has underlying fundamentals. been no lift for the auto and housing sector:
4 5 KEY MACRO RISKS HEADING: SUMMARY Here are some of the main risks, and our views: - The global co-operation that - In Italy an increase in OF OUR ASSET VIEWS helped resolve the 2008 crisis market-unfriendly headlines has dissipated with Trump’s could result in more market London & Capital uses a - Our VALUATION monitor has fracturing of global multilateral turbulence, undermining proprietary system to develop been in RED for a few quarters institutions. Nationalist investor confidence in the forward-looking views across now: after years of financial passions have already been Eurozone. assets: repression, few listed assets are stirred and it will not take much - Our MACRO monitor is flashing below historical averages. - As the Brexit deadline to reach AMBER, as weaker US cyclical to unleash a firestorm. - Our SENTIMENT monitor is in a deal approaches, concerns growth combines with subdued AMBER: there is still plenty of - The risks of a significant US will likely build that a no-deal readings in other Developed cash on the sidelines (a bullish slow-down are increasing as outcome — and associated UK Markets. There is risk that the indicator), but the start of the the economy is likely to face a and EU market turbulence — monitor turns to RED by late year rally is bound to lose number of hurdles: the end of could become a reality. next year. the fiscal impulse, the impact of momentum. the trade war, a more cautious - Our FISCAL POLICY monitor On the back of the monitors, financial backdrop and a is flashing GREEN, as populist our current Asset Allocation general global economic slow- fiscal stances spread across views can be summarised in the down. The economic expansion the globe. following way: that began following the depths - Our MONETARY POLICY - CASH - Overweight of the crisis in 2008 and 2009 is monitor is flashing GREEN, - Higher Cash positions are long in the tooth. as Central Banks have deserved. A portion of this changed tack and returned to - A significant strengthening cash should be in Gold, which accommodative stances. in financial capital adequacy is gathering momentum as (which means banks are - Our EARNINGS monitor is the strongest currency in the stronger than they have been flashing RED as embedded world. in many years) masks a rise in expectations of global - Short maturity, high quality other corporate debt. More corporate earnings remain bonds are attractive as a safe problematic, the quality of quite optimistic. Corporate haven. today’s higher debt balances is profit margins are at record worse. highs, so there is scope for disappointment on that front.
6 7 FIXED INCOME - Neutral - Reduction in non-financial MONITORS PREVIOUS NOW corporate High Yield allocation, in favour of Investment Grade and higher quality bonds. - Core exposure to financial bond MACRO space still warranted. Within financial bonds, it’s advisable to move down the risk curve. - While friendlier to bonds than equities, at some point the MONETARY POLICY macro/policy environment will separate good bonds from bad bonds. EQUITIES – Underweight FISCAL POLICY - High quality equities well positioned to capture returns in the last innings of the bull market, while being resilient on the way down. VALUATIONS ALTERNATIVES – Neutral - Truly uncorrelated alternative strategies will continue to complement the rest of portfolio. EARNINGS - Important to avoid leverage and illiquidity.
SENTIMENT
8 9 This effective lower bound can be seen as zero rates, as first muted post- DEVELOPED financial crash and of course already breached in Europe and Japan. Real-TimeReal−Time Estimates Estimates of r* and u*of real interest rates and natural rate of unemployment
FOMC Blue Chip CBO FOMC Blue Chip CBO
MARKETS OUTLOOK r* − Neutral Real Rate of Interest u* − Natural Rate of Unemployment Percent US Economic Outlook
- The Fed remains on a gradual rate cut path
- Persistently low inflation remains a key concern for the Fed - Recession risk is still relatively low as consumers just keep on spending
The Federal Open Market Committee (FOMC) delivered another 0.25% cut in September following the expected rate cut at their July meeting. The statement, the split rate cut vote and the accompanying forward-
looking rate path (the infamous dot plot) sowed some confusion, with Chairman Powell again hinting that the move was "intended to insure against downside risks". The use of the term “insurance” has led to 2012 2014 2016 2018 speculation that the Fed may not pursue a long-term easing strategy. Source: FOMC Has the Fed really shifted away from their dovish tilt? To some extent
they are less dovish than earlier this year, but the direction is still for Note: The Federal Open Market Committee (FOMC) data are quarterly, extend through June 2019, and gradual easing. In fact, the Fed has restated its concerns about slowing are projections of longer−term normal. The Blue Chip data are biannual, extend through June 2019, and are projections for 6 to 10 years in the future. The Congressional Budget Office (CBO) data are biannual growth and its fears that inflation remains below the 2% target. They and extend through January 2019. For the left panel, the projections are for 10 years in the future; the right are rightly looking at a wide swathe of inflation data, including market- panel shows the natural rate projection for the current quarter at the time of the projection. The neutral real interest rate is the 3−month Treasury bill rate projection (CBO) or the federal funds rate projection based expectations that all point to prices remaining below target for a prolonged period. Our base case for further easing over the next 12 months remains intact given the broadbased global economic slow- We re-iterate our view from the down and significant concerns over trade conflicts across multiple fronts. This view is also supported by clues the Fed has given about its past quarter that the US economy is longer-term bias in the recent Jackson Hole speech. This maps out the challenges the Fed faces given the continual drop in both the natural rate of unemployment and the neutral real rate of interest, which, combined slowing but the risk of an immediate with persistently low inflation, implies that "interest rates will run, on average, significantly closer to their effective lower bound". recession remains low
10 11 We re-iterate our view from the past quarter that the US economy is What is propping up the economy? slowing but the risk of an immediate recession remains low, even though It’s the consumer (accounting for Our base case the Treasury market is signalling a one-in-three chance of a recession. We almost 70% of GDP), buoyed by are about to enter the 124th month of expansion, setting a new record, a relatively strong labour market, for further easing and the main downside risk is still from the trade conflict damaging global decent wage growth and higher supply chains and creating uncertainty for businesses and consumers real income. The risks centre over the next 12 alike. The negative consequences are apparent as spending on equipment upon job growth slowing and real has ground to a halt whilst investment in structures (i.e. new plants and wage growth being squeezed, months remains renovation of older ones) contracted. Business intention surveys remain but on examining the underlying gloomy. An early trade resolution could be beneficial but a lot will depend trends neither are seen as an intact given the on what type of new trading arrangements are in place. Separately, from imminent risk. Nevertheless, history business spending, the housing market provides little comfort, having has taught us that a consumer broadbased contributed negatively for eight out of the past nine quarters. Even with a contraction is not a necessary supportive backdrop it is unlikely to reverse the gradual decline. precondition for a recession and we global economic must remain wary of the slowing trends across many sectors within Consumers just keep spending slow-down the economy. ercent change ercent change and significant 4. 1 . ear over year change in retai sa es right sca e) . concerns over . .
1. trade conflicts