What’s the market not seeing?
Strong deflationary currents
We believe the market is not putting enough emphasis on underlying deflationary currents. In our view there will be a limited uptick to inflationary pressures globally in 2020. Wage inflation is a key driver of inflationary pressures in developed markets, so we will need to monitor this trend carefully.
There is a limited scope for a material pick up in wage inflation, given the strong underlying deflationary pressures coming from innovation and automation in particular, but also from the ongoing competitive pressures of emerging markets in a global world. Lacklustre global economic growth is also contributing to a sluggish inflation outlook. We believe this theme carries a risk of being persistent over many years.
We believe the market is not putting enough emphasis on underlying deflationary currents. In our view there will be a limited uptick to inflationary pressures globally in 2020.
For us, it means that we are focusing on finding undervalued companies that have strong leadership position, have a good ability to innovate, operate in industries with high barriers to entry, and that therefore have good pricing power. Disruption risk is also omnipresent, and the disruption rate is actually more rapid than it has ever been. Therefore, finding companies with low disruption risk is part of that same exercise.
What’s your focus in 2020?
As long-term investors, our focus remains consistent, and doesn’t change year after year. Broadly, we continue to focus on finding attractive long-term opportunities, with our research focusing on attractive themes within the three mega-trends framework, specifically (i) Demographic Change, (ii) Future of Technology and (iii) Resource Scarcity.
The world will become ever-more disruptive
The pace of technological change seems to be increasing, helped by easier access to capital funding innovation. As a result, the speed at which disruptors are able to enter the market and challenge incumbents will continue to gain momentum in 2020.
It is therefore critical for investors to have a structured systematic approach in assessing disruption risks facing a company or an industry. Some industries are particularly challenged – we would single out transport, energy and utilities as particularly at risk, but also the financial sector which is having to respond to leaner, new entrant threats, and shifting customer expectations of how to be serviced. The technology sector is also constantly evolving, with leaders being challenged by new entrants all the time.
Cyber security takes centre stage in corporates’ focus and spend
We foresee 2020 to be a year of further focus on cyber security (notably with the US elections potentially providing an important watch point for cyber security interference of sorts). We believe that corporates will continue to up their spend on cyber security, given the increased importance it has on governance, reputational and stewardship risks. We foresee an increase in cyber attacks, which will further remind companies of the need to allocate a growing part of the IT budget to this area.
What’s the outlook for global equities?
Central banks remain accommodative and data dependent
We believe that central banks will remain accommodative across the globe, and importantly data-dependent. This should provide support for the market, and importantly for equity investors, could dictate the style leadership in the markets, with the debate around growth vs value remaining relevant.
Beyond the support that accommodative monetary policies will provide, there is a need to debate how low interest rates have become, how much lower they can go, and the repercussions of extended periods of negative rates, in terms of risky assets and savings intentions. Over and above that, there is the need to face the fact that inflationary pressures are low, and indeed underlying deflationary currents are strong.
Global Economic growth remains steady at current levels
The global economic momentum will be somewhat dependent on the ongoing US-China trade tensions, with the outlook shifting somewhat, depending on whether trade tensions ease and both nations agree to a truce, or whether tensions flare up. At this stage, based on the current developments, we believe that economic growth could remain steady in 2020 at current levels. During 2020, we could have a re-emergence of the debate around recession risk increasing, given that we are in the latter stages of what has been a long economic cycle. Our view remains as per before – we should debate the shape of a recession rather than risk of a recession.
Fiscal spending will be a talking point, but unlikely to translate into meaningful action
Fiscal stimulus could increasingly be an important talking point in the market in 2020. The rhetoric has certainly been growing in Europe recently. However, we think that there will be limited ability for that rhetoric to move into action in Europe, given the lack of coordination, or indeed, agreement on what should be done and in what shape. For the US, we think there is little scope for increased spending – the Trump tax cuts and de-facto fiscal boost from a couple of years ago will end up being a very ill-timed initiative, at a time when the economy didn’t need that extra-boost. China is likely to be the only key economy to be able to use its fiscal lever to prop up economic momentum as and when required in 2020 – we believe this will be done in a measured way, rather than translating into a large boost.
Earnings estimates will likely need to come down in 2020
While 2019 has been a year of sharp downgrades to earnings estimates, with earnings expectations for MSCI World now standing at a decline of around -2%, from around +7% expected at the start of 2019 by consensus, the 2020 estimates are still standing at a demanding +10%. We believe this is likely to have to come down from these levels, to closer to the mid-single-digit level, based on the current outlook for global growth. It means that investors will need to be selective in terms of picking the right stocks that have lower risk of downgrades, and or areas of the market where valuations are supportive despite the negative earnings momentum.
M&A activity will remain sustained and could further support equity markets
The speed at which disruptors are able to enter the market and challenge incumbents will continue to gain momentum in 2020.
As per our prediction last year, M&A activity, which typically accelerates at this stage in the economic cycle, has remained strong. So far in 2019, we have had the same M&A monetary value year to date as we had in 2018, at over US$2.2 trillion. We predict 2020 to be another strong year of M&A activity, given the ongoing low funding costs. This should be another supportive element for equity markets in 2020.
Leverage needs to be watched out at this stage in the cycle
As we are getting further in the late stage of the economic cycle, and with borrowing costs as low as a result of accommodative central bank actions, leverage will be an important area to monitor, and to watch out for any trends towards excess. We note that generally the situation here is not concerning at this stage – household borrowing is low across key regions, while corporate borrowing is not alarming either, even if more elevated in the US, with credit spreads remaining very low.
Equity valuations not demanding, supportive vs bonds
Equity valuations will be an important focal point as always. While the market valuation is not particularly cheap (being broadly in line with long-term average on a price/earnings basis), we note that the attraction of the equity yield that the MSCI World Equity index offers versus government bonds is one of the key valuation supports for the markets.
Style leadership in the market still likely to remain relevant
Earlier in 2019, we referenced the significant valuation spread between quality/growth and value styles. This remains very pronounced and will continue to be an important focal point for investors. We would reiterate what we highlighted before – that the correlation between the quality/value spread and the bond yields are an important determinant of whether we have a rotation. While we had some tentative rotation in September, this hasn’t followed through. We think we might have a few more instances of rotation, but sustainability of follow-through will be determined by whether bond yields can move higher in a meaningful way. We think this is unlikely given the tepid economic growth outlook and lack of sustained inflationary pressure. We are therefore of the view that any style rotations will be short lived.
ESG and sustainability moves into the mainstream for corporates and investors
With an ever-greater focus on sustainability issues, particularly climate change, we believe that corporates and investors alike will increasingly focus on ESG matters in 2020 and beyond. Some investors will be demanding a far greater ESG focus from their asset managers, with the trend likely to continue to gather pace over the years to come. This makes it critical for asset allocators to assess whether their portfolio managers genuinely and materially integrate ESG analysis into their process and can demonstrate real expertise of engagement.
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