Lower investment risks and an improved outlook have allowed markets to chalk up gains recently. But… do not chase risky assets such as equities aggressively now // The appropriate stance for investors: ‘buy the dip’
In our view, the recent goldilocks scenario – with ‘not too hot’ growth and ‘not too cold’ inflation – still holds. In fact, this favourable backdrop looks less fragile now with threats such as escalating trade tensions and a pronounced economic slowdown having diminished.
As this typically benefits risky assets, we have already seen strong returns in recent weeks. Indeed, selected markets have set all-time highs.
For these gains to hold, and possibly be expanded, the market will require positive earnings news. So far, company reports on Q4 2019 earnings have been encouraging: 45% of US companies have reported and shown solid surprises on earnings and sales (Exhibit 1).
Exhibit 1: The latest company updates on earnings and sales have exceeded market expectations and appear to mark an end to the slippage seen in Q2 and Q3 of last year – graph shows quarterly US company sales and earnings growth in % as reported to date
Source: Bloomberg and BNPP AM, as of 31/01/2020
How strongly earnings will come through will be pivotal in determining 2020 equity returns. Thus, it is one of the main elements on our radar.
So, for now, we are watching for market dips to take long positions, sticking with a strategy that paid off in 2019 (Exhibit 2).
Exhibit 2: Waiting for a dip to buy equities at more attractive prices than currently available in the market – graph shows the 2019 run of the US S&P500 index and the times at which we bought (‘entry points’)
Source: Bloomberg and BNPP AM, as of 31/01/2020
Among the factors propping up ‘goldilocks’, we foresee continued support from an accommodative stance from the major central banks, meaning that interest rates will remain low for the foreseeable future. This should prolong the search for yield by investors.
In this light, we are overweight emerging market debt in US dollars. We see three reasons for this position. First, EM debt typically does well in times of central bank easing and stable or falling yields. Second, it is one of the few liquid fixed income asset classes that yields close to 5% in USD terms. Finally, EM risk premia tend to fall when Chinese policy is being eased, which is the case currently.
Real estate investment trusts (REITs) are another market that should be supported by investors searching for yield. We like eurozone REITs given that share prices are close to their five-year lows relative to net asset value. REITs offer an attractive yield, and being a real asset, they have defensive characteristics, which are helpful in the case of a downturn or higher inflation.
We see fixed income markets as expensive, not least in light of the risk of reflation (which would drive yields up and, conversely, prices down). We believe decades of muted inflation have inured bond investors generally when it comes to the scope for inflation to pick up. Accordingly, we see the reward of being underweight core government bonds as attractive in the medium to long term.
Read the full text of our asset allocation monthly Less fragile goldilocks, but don’t chase markets
Watch our asset allocation video with Maximilian Moldaschl
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.