Financial markets: Q&A

Since publishing our Outlook 2020 in mid November, we have met numerous clients. The article below reviews the main questions on their mind.

Should I fear a recession?

No. Although a recession is always a risk, especially for growth-sensitive assets such as equities, high-yield bonds or industrial commodities, we do not expect a global recession in 2020. Last year, the inversion of the US yield curve was seen by many as a sign of impending recession. But based on the fundamental data like economic growth, we always thought that those risks were overstated.

The yield curve has now reverted to its typical, upward slopping, shape and other indicators tracking recession risks, such as the New York Fed recession gauge, are off their highs. While a 2020 recession can’t be completely ruled out, we don’t think that the risk is high.

What about stretched asset valuations?

It is true that valuations are demanding for most asset classes. However, valuation is a very poor indicator to determine short-term performance. There is almost no correlation between valuations and the performance of an asset class over the next 12 months.

Valuation is relevant when assessing long-term (more than five years) return expectations. High valuations indicate that returns for the next few years, at the asset class level, are probably going to be lower than they have been in the past 10 years.

So shouldn’t I just hold cash?

While returns over the next few years might be lower, holding cash will provide you with real negative returns at the moment. The key metric to look at is real rates, that is nominal rates adjusted for inflation. This metric is negative in much of the developed world. This means that the purchasing power of a cash holding falls with every passing day.

While returns might not be as high as they have been since 2008, we still expect a mix of asset classes to deliver positive real returns over the next few years.

Given the risks, why not buy on the dip?

Yes, there are lots of “known unknowns” and we highlighted the main risks in our Outlook 2020 (such as an inflation surprise, higher yields, trade tensions and geopolitical risks). In the current environment there are more candidates than usual that could trigger market-disrupting events. But corrections during bull markets are usually short-lived and notoriously difficult to time. They last between 1-3 months on average and markets then typically recover over 2-3 months.

But despite this, timing the market is a futile exercise which has more to do with luck than skill. In contrast, selecting a diversified portfolio of quality assets which is likely to outperform in the long term requires more skill than luck.

What type of investment do you like?

As we discussed in more details in our Outlook 2020, we think that diversification, active management and yield enhancement are three characteristics that we look for when investing in the current market environment.

We have a preference for emerging market debt within fixed income, while quality companies able to generate steady cash-flow remain our preference when it comes to equities. While gold on its own is not attractive, it provides welcome diversification when part of a broad, cross-asset portfolio.

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