Perspective - Economics
Outlook 2020: Global equities
Stock market volatility is likely to increase and stock selection will become more important, as global uncertainty continues and the US bull market shows early signs of exhaustion.
3 December 2019
- Political tensions, such as the US-China trade war and Brexit will remain in the forefront, with poor sentiment undermining global capital spending and growth.
- There is a wider than average disparity between sectors offering perceived safety and stability (such as utilities, real estate and consumer staples), and those exposed to global trade. Earnings expectations in unloved sectors, such as industrials, are low, giving scope for positive surprise.
- Amid the noise of markets, we believe global themes such as climate change, energy transition, sustainability, disruption and innovative healthcare will become more prevalent.
Global growth in 2019 has been slowing and this will likely continue in 2020 as trade wars and political turmoil persist. Economic data have worsened significantly in many countries around the world, perhaps most notably the purchasing managers indexes, which are based on survey data from the manufacturing and service sectors.
The ongoing US-China trade war is weakening confidence and sentiment, with the uncertainty rippling out to markets in other countries. China, as a “command and control” economy has reacted to the trade dispute quicker than the market-driven US, sharply cutting US imports. Although the US export sector is not that big relative to the domestic economy, the effects are visible in lower levels of business investment. This is likely to persist into 2020 and will be marked in economies more exposed to global trade, such as Germany and Japan.
Little scope for rate cuts, except in the US
Despite three rate cuts so far in 2019, the US is one of the few developed economies with scope to cut further. Whether this would have any impact on growth remains to be seen. Interest rates in many parts of the world (for example, Japan, the eurozone and Switzerland) are already in negative territory. Emerging markets, such as Russia, Brazil, India and China, have the most scope to cut interest rates since rates in these countries are still relatively elevated.
A number of countries have the tax revenue to bolster spending in a bid to stimulate growth. South Korea, Germany and the Netherlands have substantial scope to spend, but are hesitant to do so or have constitutional limits on government spending. It seems more likely that countries with a recent history of austerity (such as Spain, Greece, Italy, and the UK), or where there has been regime change (Brazil, Mexico, parts of Eastern Europe) will switch gears and expand their budgets.
Market focus is gradually shifting
Market sentiment already reflects much of the gloomy macroeconomic outlook and earnings estimates for 2019 as a whole have come down materially. Third-quarter earnings in the US fell 4% from the same period last year, but were better than expected, particularly when cyclical sectors such as energy are excluded. Cyclical stocks are those that are most affected by changes in the wider economy. The low expected rate of return, coupled with the fact that overall valuations are not egregious in a historical context, probably explains why markets have continued to perform relatively well despite the general uncertainty.
In the short-term, momentum in the US economy is likely to remain strong. But, as we move into 2020, factors such as capacity constraints (that is, a limit to the amount of goods that can be produced, primarily due to full employment), higher input costs and deferred investment decisions will start to create the conditions for a gradual slowdown. These conditions would be exacerbated by a change of regime, since a Democrat victory in the autumn elections could have a major impact in areas such as healthcare. US profit margins remain at record levels (excluding energy) and the trend is probably downward from here. Earnings estimates in aggregate for the US, indicating growth of +11% year-on-year for the S&P, still look a stretch.
In contrast, in economies already in or close to recession (such as Germany, Japan, the UK and Australia), expectations look more muted. We cannot see any catalysts for a powerful upturn in growth in most countries outside the US. Unloved, cyclical companies may find favour again after a long period of under-performance, especially those that re-structure and re-position to meet the challenges of the next decade.
Global themes offer long-term investment opportunities
Given the levels of uncertainty affecting the global economy, the range of potential macro-economic outcomes is quite wide. Following a 10-year period in which the S&P 500 has delivered a 250% total return (in US$) and global equities have more than doubled, it seems reasonable to assume more modest returns from equities going forward. Against that backdrop, we believe that it may be beneficial for investors to focus on a number of broad, long-term global themes that present significant positive investment opportunities, which in many cases are uncorrelated with traditional equity indices.
For example, whilst the realities of rising global temperatures are rapidly becoming apparent to politicians and populations alike, the financial scale of the climate change problem is still massively under-estimated. In order to stabilise global temperatures within the +2 degrees C limit defined as “safe” by the Intergovernmental Panel on Climate Change (IPCC), spending on greenhouse gas mitigation will have to rise to at least $2 trillion a year over the next 10 years. That cost will have to be borne by governments, consumers and of course, companies.
Within the latter group there will be a significant number of beneficiaries from the switch to more sustainable activity. The process of energy transition is already well underway, despite rather lukewarm support from many governments, including the US. Happily, economic reason continues to prevail, and the overwhelming cost advantage of wind and solar versus traditional generation sources (see chart below) is translating into a massive uplift for many renewable energy companies.
The future will be electric
It is a similar picture within the automotive industry, with sales of electric vehicles (EVs) set to increase hugely in the next few years driven by a more favourable regulatory framework in many countries (such as Norway, with a total ban on the sale of new internal combustion engines vehicles by 2025). Ultimately though, demand will be determined by the attractiveness of the products themselves. As these improve, consumers will surely migrate to EVs in the same way they adopted e-mail, mobile phones or internet shopping.
Climate change is but one of a number of broad, pervasive themes with which we can all identify. Others include sustainability, technological innovation, automation, urbanization, and changing demographics. These are all “inescapable truths”: long-standing in many cases, but becoming increasingly powerful in a world in which disruption is omnipresent. It would seem inherently sensible for investors to move at least some of their assets away from traditional market-cap strategies and toward those areas where there is likely to be structural growth. In that context, thematic investing has come of age.
- You can read and watch more from our 2020 outlook series here
The opinions above include forecasted views that should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors, they should not be taken as advice or a recommendation to buy and/or sell.
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