From global trade tensions, Brexit to a change in UK government, there have been many events driving economic uncertainty.
Royal London Asset Management’s Trevor Greetham, Head of Multi Asset, and Melanie Baker, Senior Economist, examine the global economic outlook, explain how this impacts their Investment Clock model, and tell us what they think advisers should be considering when building a centralised investment proposition.
What’s been driving the slowdown in the world economy and is that now changing?
Melanie: This kind of got going in 2018 and was driven by a couple of things really. In particular, we had an increase in trade tensions globally, particularly between the US and China. We had interest rate increases in the US as well. Actually, we had a generalised slowdown in China, too. It started changing already in the early part of 2019; we had a change in direction in the US, followed by actual interest rate cuts in the US.
More recently we’ve had some easing in trade tensions too, which helps the global outlook. And of course if you think about heading into 2020, that monetary policy stimulus we’ve been seeing in the US will still help the global economy, and we’ve had signs of more fiscal stimulus and announcements in various economies too, so things do look set for a better 2020 as we go through the year. Actually, the data is showing signs of bottoming out as well.
Why have risk assets done so well this year even though the global economy slowed?
Trevor: Well, the world economy has slowed over the last couple of years, but we link what’s happening in the world economy to what we think financial markets will do using our investment clock model. And this time a year ago, at the back end of 2018, we had a global slowdown with rising inflation. We call that stagflation. It’s very bad for stocks; stock markets were really, really weak running into Christmas, and that gave us a very low starting point to 2019 for stock markets. What happened over 2019, as Melanie has described, is that global inflation came down because oil prices also crashed when stock markets did, and that meant central banks could cut interest rates, so we had a disinflationary backdrop. Our investment clock moved from stagflation to reflation and then gradually it’s showing more signs of recovery as the year progresses. And stock markets tend to anticipate what they think’s going to happen next in the world economy, and basically what happened over 2019 is the market started the year worried about recession and ended the year not so worried.
So how strong will the recovery in the global economy be?
Melanie: In terms of the strength of recovery, it’s probably not going to be very strong. So, if you think about the downturn of the global economy that we’ve had, it’s just not sharp enough to expect a sharp upturn after that. In terms of the stimulus that’s been added, it’s just not enough to expect a really sharp bounce, particularly if you think about the kind of stimulus that’s been added in the Euro area, for example, or China for that matter. And, then there’s the trade tensions story and lingering uncertainty. I don’t think we’ve seen the last of US/China trade tensions, and I don’t think we’ve seen the last in terms of tariff threats from President Trump.
Trevor: And we’ve also got tariff threats around the Brexit negotiations as well, unfortunately.
Melanie: Absolutely, and that’s been important for European economies broadly.
Do you think we’ve seen the best of the rally in stocks?
Trevor: I don’t think we’ve seen the best in the rally of stocks. If you think about what’s driving stock markets, if the world economy is recovering, even if it’s a gradual recovery, it’s the right direction for investors. They’ll see improvements in corporate earnings. Stock markets aren’t horribly expensive, and interest rates are likely to stay low. We think that combination is quite good for stocks. So, we were overweight stocks in our multi-asset funds throughout 2019 and we expect to be overweight in 2020 as well.
We’ve spoken globally, but is the economic outlook different for the UK?
Melanie: The global outlook is, actually, somewhat similar to the UK. We are going to have, and we have already seen some fiscal stimulus in the UK which will help, we just don’t know quite exactly when it’s going to come in and how strong it will be until we’ve seen the budget. But there is a sort of lingering uncertainty that will continue to dampen business investment. The businesses are worried about Brexit, they’ve been worried about what the end relationship between the UK and the Euro area will look like, and they’ve been worried about the possibility of an abrupt change in trading conditions, and they still need to worry about that for the end of 2020, so it will probably be a lingering drag.
What does the new government in the UK mean for markets?
Trevor: The new government in the UK has resolved one question: we know Brexit is going to happen. But another big question is still open, which is we don’t know what kind of Brexit we’re going to get. There’s a large enough conservative majority that prime minister Johnson, if he wants to, can negotiate a much closer trading arrangement with Europe, our largest trading partner. But on the other hand, he’s saying, at the moment, that he won’t extend the transition deadline of December 2020 and is talking about a much looser arrangement which could be a bit of a shock for markets. I think in the short term though, people are going to be much more focused on fiscal stimulus, as Melanie mentioned, so the early part of the year could involve more government spending announcements on infrastructure, say in the North of England, possibly targeted tax cuts here and there, potentially another interest rate cut from the Bank of England, because uncertainty is still lingering. I think the markets are, at the moment, focusing on the potential positives from that boost to growth, so you’re seeing things like midcap stocks doing quite well. Sterling has sort of strengthened a bit, but then it wobbled again and sold off because of concerns over trading arrangements, so I think we’ll see that see-sawing between positivity around domestic stimulus and worries that we’ll end up with potentially quite a damaging arrangement in terms of trade.
So, bearing all of that in mind, what should advisers consider when building centralised investment propositions?
Trevor: We think advisers, when building centralised investment propositions, should start off thinking very much about diversification, so you need some assets in a portfolio which are there to seek long term growth. For us we would use UK and global equities, we’d also have some exposure to commercial property in the UK and commodities. Each of those in turn tends to do best at slightly different times. In the UK, in particular, with political risk around Brexit still lingering, we think it’s very important to have that mixture of property plus shares, because normally if something happens that’s good for the UK economy, commercial property should go up, if something happens in terms of negotiations that’s bad for the UK economy, property may be a bit more challenged, but if the pound weakens that really boosts overseas earnings and the value of overseas holdings and shares and commodities, and we think that mixture gives you proper diversification. Also, you need fixed income exposure as a store of value, so we have corporate bonds, high yield bonds, government bonds, and cash. So, it’s a really diversified exposure, not necessarily looking to really exotic, funky asset classes, but just a good range of things.
We think it’s very important to manage that portfolio actively, so as the world economy shifts from one phase to another of the investment clock or as the political situation changes, if you’ve got a team of people who are moving assets, over and underweighting different asset classes as their prospects improve, we think that can help to add additional value, and it can also help to mitigate against losses when things go wrong. It’s a mixture of asset classes actively managed, we think that’s the way to go.