Summary of market performance
By Enrique Marazuela.
- 2020 is starting from a better place than 2019, since the economic slowdown has ended, global risks have excluded the most drastic scenarios and there will be monetary stability at very lax levels.
- We're reiterating the importance of diversification. We're recommending to our customers that they hold all types of assets, in the ratios that are consistent with their risk profile and their goals and objectives.
- We are underweighted in European, central and peripheral public bonds, neutral in corporate bonds and overweighted in emerging bonds, especially those denominated in local currency and those of Asian issuers. We're bullish on equities.
- Sustainability is much more than a passing interest for those companies that have this label, it's a trend that's here to stay and that will affect all asset classes and all companies.
It may seem paradoxical but 2019, which was a fantastic year for all types of financial assets, started out with a very weak outlook: the collapse of the financial markets in the last stretch of 2018, a persistent slowdown in growth, which started in late 2017, the threat of new rate increases by the Fed, global tensions between China and the United States, Brexit, etc.
So, with 2019 being a year of gradual improvement, we believe that the main catalyst has been the shift in monetary policy, most notably by the Fed. The reduced tensions between China and the USA, as well as Brexit, both of which occurred in the final quarter of last year, have also been particularly relevant.
The start of 2020 bodes well for the financial markets:
- The slowdown seems to have hit bottom and now we're talking about growth stabilization.
- Inflation will continue on the sidelines and will allow central banks to remain in their comfort zone.
- The price of oil will not be a threat to inflation, despite the occasional geopolitical conflicts. We do have to be aware of the outlook for American production, which has allowed an abundant supply in recent years.
- There will be continuity in monetary policies, which will maintain their current lax approach.
- The main risks of 2019, such as the trade tension between China and the United States, and Brexit (which were alleviated in the latter part of last year), will continue to be present in 2020, although extreme outcomes seem unlikely.
- In 2020, the US presidential elections will play a prominent role and provide an additional risk to those mentioned in the previous point.
This is good news for risk asset markets. However, we can't jump for joy in 2020, since the significant increases in prices last year have left valuations at very demanding levels.
Before analyzing the different types of financial assets, we want to point out something that should be a constant in your portfolio: diversification. It is good to invest in each and every financial asset class, at a proportion that is compatible with your risk profile and with your goals and objectives.
We believe that the valuation of European government bonds, for both central and peripheral countries, is excessive. This is due to the low yields on public bonds, which in many cases are even negative. The current lax approach to monetary stability will prevent meltdowns in the price of debt, but we can't rule out a higher slope in the curves (increased returns on bonds with longer periods of maturity and stability in those of the shorter-term bonds).
If there are positive surprises in the recovery, whether in terms of economic growth or inflation, which would be a likely scenario if governments apply an expansive fiscal policy to reactivate the recovery, we would see higher slopes.
In corporate bonds, the expected returns, when adjusted for risk, are much more balanced, but not enough to make them appealing. The yield differential, which is the metric we use to measure valuation, is in the lower portion of its range from the last decade, meaning they are on the expensive side. Although growth may yield some surprises due to the monetary stability, which is good news for this kind of asset, we don't anticipate any new tightening of the aforementioned differential, precisely because of its current low levels.
Therefore, we remain neutral, which is a common recommendation for all corporate bonds, whether they are of the investment grade or high yield variety.
Our commitment to emerging bonds continues, despite the significant increases in their prices in 2019, based on a context that continues to be favorable due to the improved expectations of global economic growth, the continuity of the Fed's monetary policy and a stable dollar. We prefer emerging bonds in local currencies, although they are riskier than those denominated in strong currencies, with Asia being our favorite area.
We don't think the dollar will strengthen in 2020.
We're bullish on equities. All the increases that occurred in 2019 are explained by an increase in valuation, since corporate profits have remained basically flat. The end of the slowdown and monetary stability are good news for stocks, although they are already priced in. For these to continue rising, we need to see an increase in profits, which will be closely linked to sales, since the margins are so high that they are unlikely to expand. By regions, we see an advantage in Europe due to its more cyclical tone.
Sustainability is vitally important in investments, especially to prevent risks; suppose a company that engages in an activity that is not sustainable faces severe uncertainties. The following could happen:
- Its clients, increasingly mindful of this issue, go elsewhere.
- Authorities may regulate its activity or even prohibit it. They can also opt to tax it, which is one way to repair the associated social and environmental impacts.
Even though a new trend has emerged with sustainability in those companies that have this label assigned to them, we think it's going much further. It's a structural trend.
To be clear, this is a trend that's here to stay and that will have effects across the board, affecting all asset classes and every activity. We believe that sustainability will have to be considered as an essential aspect of any investment analysis. Sustainability, in addition to mitigating risks, is profitable.