At the beginning of every Chinese New Year, AsianInvestor makes 10 predictions about the economic, political and financial developments that are likely to have an impact on the way institutional investors assign their money.
Our latest Year of the Pig outlook considers the prospects for global bonds and equities, and how institutional investors in the region might position their portfolios as a result.
Will fixed income outperform equities?
Answer: No (but equities will only outdo bonds marginally)
After a tumultuous 2018, investors have hunkered down expecting global financial markets to remain volatile. Gone are the expectations for double-digit returns in equities while bonds are no longer the safe-haven assets they used to be.
Unlike at the start of 2018, when there was near-unanimous enthusiasm for emerging market equities, neither equities nor bonds get an unconditional thumbs-up.
Maybe that isn’t such a bad thing, given that last year’s favourite (emerging market equities) ended losing around 14.5%, based on how the benchmark MSCI Emerging Markets index performed.
This year, there is much more caution and low conviction around the prospects for both equities and bonds because of the various storm clouds looming on the horizon. A slowing global economy coupled with tightening global liquidity (the Federal Reserve may have recently signalled that a rate-hike pause may not be far away but it's still shrinking its balance sheet), concerns over Brexit, along with simmering US-China trade tensions promise to keep investors on edge for most of the year.
Fears of a possible US recession in 2020 also nag, even if others think a soft landing is possible.
All of this doesn’t leave much room to take on high risk, and that is likely to mean allocations to equities are unlikely to increase significantly among asset owners, according to the consultants and investment specialists AsianInvestor spoke to.
Within the equities universe, stock-picking skills are expected to become more important as increased volatility leads to greater variance in the way shares behave – at least, active managers hope, as they strive to differentiate themselves from their passive peers by beating the market.
Equity valuations seem more reasonable after the market turbulence of 2018, but with economic growth slowing in most countries, profit expectations are also being revised downwards.
“Profit expectations [for global equities] are mostly in single digits and low single digits at that,” one London-based multi-asset specialist at a US-headquartered firm told AsianInvestor.
In the search for alpha, institutional investors could also show a preference for developed market equities, said one quant specialist with a European fund house.
Certainly, the love affair with emerging market stocks has cooled of late, especially after China’s growth slowed to a 28-year low of 6.6% last year and the prospects of a prolonged trade war with the US intensified.
Nevertheless, after the battering China A-shares received in 2018 (the Shanghai Composite index dropped by 25%), the bargain hunters are predictably on the prowl.
Overall, emerging market equities could see intermittent buying throughout the year. However, don’t expect significantly greater allocations from institutional investors, seems to be the underlying message.
That’s because emerging economies, in general, could experience more turbulence, especially if global trade slows further and adds to the pressure on their export revenues and currencies. In this respect, trade-orientated developed economies like Singapore and Taiwan are also in the crossfire.
Throw in the tighter policy conditions after nine US interest rate rises (and maybe a tenth still to come) – historically a negative for flows into emerging markets – and you can see why investors are not rushing into this segment of the equity market.
Emerging market debt also seems to be relatively out of favour with the region’s institutional investors, according to one senior consultant, who engages with pension funds and sovereign wealth funds.
“If anything, I think some of my clients are looking to exit their [emerging market debt] positions. Some of them entered [the market] too early and have seen little gains,” she told AsianInvestor.
That said, other parts of the global bond market are also not particularly enticing. With global economic growth slowing, debt levels high, nagging worries of a US recession further ahead, and US interest rates not as low as they used to be, the outlook for corporate credit is expected to become weaker.
The US leveraged loans market, for example, is one notable source of concern highlighted by investors such as HK-based insurer FWD.
Nevertheless, US Treasuries and German Bunds could benefit if risk-averse investors are sent scattering again by an increase in market volatility.
As with equities, the trick could be in being highly selective with bonds – another reason why we believe active management will become much more important than it has been for nearly a decade.
Still, given the way the global economy looks, it seems unlikely that equities or bonds will have an outstanding year.
Our call: equities will beat bonds in 2019, even adjusting for risk. But only just.
Previous Year of the Pig predictions: