Rick Rieder, Russ Brownback and Trevor Slaven contend that eight major market influences are likely to dominate the investment environment in the year ahead and that the proper portfolio mix will be instrumental in delivering a successful outcome.
In our industry, we can safely rely on the turn of the calendar year to bring with it an overflowing inbox of “bold calls” for year ahead. Through the barrage of 2020 predictions, sector bets, benchmark target revisions, and the like, we are struck by the sobering reality that it will be incredibly difficult for asset markets to repeat the heroic returns of 2019 this year. Notwithstanding a fundamental environment that appears to be stabilizing, more dovish global central banks, and a meaningful reduction in trade tensions, fulsome market valuations abound, leaving less room for upside and little margin of safety should any of these influences reverse, or should unforeseen new risks arise.
As such, we think a 4% to 5% returning portfolio would be a winner in fixed income in 2020. Our “Drive for 5(%)” centers around building a barbell portfolio, underpinned on one side by high quality fixed income, with carefully selected equity and alternative assets on the other. This portfolio mix will be instrumental in successfully navigating a macro environment that is likely to be dominated by eight major influences:
1) Global Liquidity is vital in determining the investment opportunity set
Global liquidity is the most dominant, yet underappreciated, influence in contemporary global macro analysis. Central banks allowed liquidity to contract in 2018 and in early-2019, but they pivoted sharply over recent months. Liquidity injections in the fourth quarter of 2019 retraced more than half of the 2018-19 contraction. Further, we forecast that global liquidity will grow by an additional $1 trillion this year, providing important support for the economy and financial markets. Through 2020, there is a risk that liquidity is actually oversupplied and that central banks ultimately intervene verbally, to slow the momentum of liquidity-fueled risk rallies.
2) A yawning supply/demand imbalance in global assets will continue to be immensely powerful
We’re astounded by the massive capital flows seeking out the inherent stability of bonds and cash, as well as the record amounts of corporate stock buybacks. Both these actions are presumably being pursued by investors due to a perceived lack of attractive investment alternatives for cash. These phenomena are exacerbated by the crowding-out effect that surging global liquidity intentionally creates. Central bank asset purchases, combined with companies that are simply rolling existing debt without adding new borrowing, means that the net new supply of fixed income assets is likely to be some $400 to $500 billion lower than last year. Supply is not only contracting; it continues to be insufficient to match the demand from a global demographic transition of people that are heading into retirement in 2020 and the next decade – a cohort bringing with them into their golden years an intensifying bid for yield against a shrinking pool of available income (see graph).
3) 1.8% will be a guidepost for navigating financial and real economy ups-and-downs
Unlike some market commentators’ more dramatic predictions for 2020, we see a more moderate path for both U.S. growth and inflation this year, at about 1.8%. Today’s service-oriented economy, driven by technology, health care and consumer services, is largely insulated from the traditional cyclical influences that are more the hallmarks of an industrial economy. In fact, we wonder whether a traditional business cycle exists in precisely the same way anymore. Demographic headwinds are shifting global demand curves to the left and are driving equilibrium economic growth rates lower. With “muted” economic stability around 1.8%, global liquidity becomes the tail that wags the dog in the absence of big “macroeconomic imbalances.” We are prepared to fade extreme price moves when markets inevitably adopt more extreme views (in either direction) over the course of the year.