At the start of the 2020s, markets continued to be dominated by geopolitical issues, with short-lived Iran tensions at the forefront initially, followed by the news regarding a phase one trade deal between the US and China. Now, growth expectations are becoming the main driver of the market. That’s why the recent volatility due to the news about the spreading of the coronavirus in China is higher than in the case of US-Iran tensions, as the epidemic could harm China (and global growth) if not contained soon (not our base case at the moment).
Other than this issue, recent data point to a ‘so far, so good’ assessment as Germany has avoided a recession and the Euro area is bottoming out. Inflation uptrends are materializing to some extent, but risks appear to be limited and the overall inflation outlook remains benign. Central banks are likely to continue to pause on policy changes, which should help to maintain dovish financial conditions across regions. Therefore, in the search for further growth, attention is globally moving towards fiscal measures: Japanese stimulus package; approval of 2020 Budget Laws for Indonesia, the Philippines and India; and hopes for support in Germany, the UK and broader Europe (€1tn European Green Deal).
Green investing and climate change are increasing themes to watch in 2020. Whether it was the recently released 2020 World Economic Forum report or the latest Davos WEF, climate change and environmental risks are dominating discussions. Europe and China are working together to reduce emissions by launching the Emission Trading System (ETS) which will be the largest carbon market worldwide. Climate change could also be a strong theme in the US electoral debate as global disasters, such as the Australian bushfires, put pressure on politicians to act. Overall, green objectives could be the catalyst for fiscal push, but they could also become the new frontier for trade wars as the European Green Deal considers the possibility of an EU carbon border tax. From a top-down perspective, the interplay between geopolitics, growth and green issues will likely be the main theme driving the risk-on/risk-off mood.
From a bottom-up standpoint, credit market dynamics should be the key driver of the financial cycle. The narrative of low rates continues to play in favor of the asset class, despite rich, though not extreme, valuations. Thus, we believe investors should be overweight credit. However, some idiosyncratic stories could still pop up, especially if renewed concerns about a slowdown play out. We believe flexibility and selectivity in managing this asset will be key in generating returns this year.
This backdrop translates into some key investment convictions:
- It is not a time to be too defensive. Some short-term issues related to the coronavirus in China or EuropeUS trade negotiations may open buying opportunities to add to risk assets. If the situation in China stabilizes, growth momentum may improve in a low yield environment. Beyond the short term, when US equities may prove more resilient, Europe is the market in which to play cyclical value themes. We would add exposure to EM equities, with earnings expectations gaining traction, once virus issues fade.
- In bonds, the focus remains less on the duration play and more on credit picking. Europe, EM bonds and US securitized assets are the way to play the continuing risk-on phase.
- Selection in focus. Given tighter spreads, more expensive equity markets globally, and overall exposure to the “growth factor” across the board, selection is crucial so that investors are not caught in less valuable names that could hurt returns if volatility rises. Selection should rely on fundamentals as well as on ESG, taking into consideration all the risk factors that could affect future business valuations, of which climate change remains the most discussed.
Finally, ESG will be the area that sees new regulations. This should be the case in the financial sector as well. As shareholders are becoming increasingly demanding on all ESG fronts, we expect to see a rise in the impact of ESG on market performances.
Authors:from Amundi Asset Management
Pascal Blanqé, Group Chief Investment Officer
Vincent Mortier, Deputy Group Chief Investment Officer