Legg Mason affiliates: 2020 outlooks
Below, affiliates of Legg Mason, the international asset management firm, provide their annual outlooks for the global economy and key asset classes.
US and international equities – ClearBridge Investments (Jeff Schulze, Investment Strategist)
‘As we enter 2020, both the US and global economies are clearly slowing; the key question is whether we are on the cusp of a recession or a late-cycle slowdown.
‘Our base case is for a slowdown within an ongoing economic expansion. While we expect the contraction of the manufacturing sector to marginally worsen as the ongoing trade war hurts business confidence and slows capex, the consumer side of the economy should remain strong enough to avert recession. The labour market and wage growth are healthy, which should underpin consumer spending, while the Fed has joined with central banks around the world in ramping up monetary accommodation.
‘While volatility will likely remain elevated, a market drawdown next year is not imminent. In fact, over the last 19 US presidential election cycles, stocks have suffered losses just twice in the 12 months leading up to election day, delivering an average return of 8%. Equities have also tended to do well in periods following a yield curve inversion, especially if no recession occurs, rising 13.5% on average in the subsequent 12 months. The 2-year/10-year US Treasury yield curve inverted in August, suggesting that stocks could climb through most of next year.
‘Cyclicals have gotten a boost from the Fed easing, but this rally could be short-lived; we do not believe the manufacturing side of the economy is out of the woods yet. For example, corporate credit spreads at the lowest quality ratings, which encompass energy, industrials and some retail names, are at their widest levels in over a year.
‘Instead, the likelihood of continued volatility in 2020 steers us to high-quality growth companies with strong moats around their businesses and more defensive areas of the market that have tended to hold up well during turbulent periods. Consumer staples and utilities should continue to lead unless we see a clear resolution of the trade war and improvement in global growth.
‘One of the benefits of these stocks is dividends, particularly given the low yields on bonds in general. It’s worth noting that through the third quarter of 2019, 42% of S&P 500 stocks had a higher dividend yield than the 30-year US Treasury bond.’
International Equities (Elisa Mazen, Head of Global Growth Equity investment team)
‘We remain very optimistic about non-US growth equities, particularly in Europe. People tend to talk negatively about Europe, but many of these growth equity companies continue to do very well. There has been a selloff in growth versus value, but that should come back. Good opportunities exist for continued earnings growth and even multiple expansion. European growth equities, compared to counterparts anywhere else, are very inexpensive.
‘Valuations in the United Kingdom and Europe are attractive, particularly compared with US equities. European stocks are at 50-year lows vs the US, which has represented a good entry point the last two times performance dispersions became this extreme. Near-term risks in Italy are contained for now with a new moderate government in place. Fiscal stimulus is being discussed within the EU, which would be a clear positive.
Global economy / fixed income – Western Asset (Ken Leech, Chief Investment Officer)
‘While downside risks have risen this year, we believe global growth should prove to be resilient in 2020. We think global growth next year should best be characterized as “less slow.” We remain encouraged by the ongoing strength of the consumer globally and the enormous amount of monetary stimulus supplied by both developed market and emerging market (EM) central banks — the combined weight of these two forces should truncate downside growth risks as we move closer to 2020.
‘In the US, we’re encouraged by a recent rebound in consumer spending and a tentative improvement in manufacturing data. We see nothing in Fed policy nor in the ongoing growth rates of nominal GDP that would suggest any inflation spikes over the near- to mid-term. We are fairly optimistic for the US economy in 2020.
‘For the eurozone, while there are many downside risks and some countries might be at the brink of a technical recession, we think the market has become too pessimistic and we look for growth to recover modestly next year. We expect the German economy to accelerate in 2020 and a growth rebound in Italy on abating political noise. Other large eurozone countries could slow somewhat, but are likely to grow supported by accommodative monetary and fiscal policies across the continent.
‘This macro backdrop, along with reasonably solid credit fundamentals, is likely to continue to provide strong technical support for corporate bonds. The US investment-grade market remains a compelling destination for global investors given its size, liquidity and attractive yield, relative to the UK, Europe and Japan. With inflation declining in many EM countries — which allows central banks to lower rates and support economic activity — we also believe EM real yields look attractive with additional room to compress.’
China & Asia (Desmond Soon, Head of Investment Management, Asia (ex-Japan))
‘China’s economy is slowing for both structural and cyclical reasons at a time when the global economy is softening. We are not of the view that Chinese policymakers will use currency devaluation as a policy instrument. Against this backdrop, it makes sense for Chinese policymakers to give domestic producers breathing room through a currency devaluation. Regarding US-China trade tensions, we do not expect to see a quick permanent turnaround in the near term, as neither country appears keen to concede meaningful ground. Looking ahead, escalating tensions and uncertainty will continue to weigh on sentiment, leading to further drags on capital expenditures and consumer confidence.
‘Developed economies in Asia generally look well poised to provide fiscal easing to address near-term cyclical shocks from trade tensions and structural headwinds from the global economy. Those likely to increase policy accommodation include Korea, Singapore, Hong Kong and Taiwan. Yet in EM economies, the case for structural reforms — for removing more barriers to foreign investment, increasing banking system liquidity to support domestic corporates and for infrastructure investment — remains critical.’
Infrastructure – RARE (Nick Langley, Co-Founder, Senior Portfolio Manager)
‘2019 has seen a continuation of the 2018 trend of decelerating global growth, but we believe this has likely troughed for key economies – think of it as a late-cycle pause rather than a slide into recession.
Inflation was missing in action in 2019, and we see no signs of a breakout anytime soon, which should result in bond yields being lower for longer.
‘Political uncertainty and the shift toward nationalistic policies and approaches have created uncertainty for corporates and delayed investment decisions. Infrastructure has been spared this theme as regulators continue to approve projects driving near-record asset base growth and giving certainty to future earnings growth across the sector.
‘The importance of earnings growth and confidence that companies will not disappoint continues to support higher multiples in the infrastructure sector, which are now at the high end of the relatively tight trading range since the global financial crisis. Current multiples appear reasonable given confidence in the underlying growth in asset bases driving growth in earnings, cash flows and dividends across the sector.
‘Infrastructure will likely continue to be in the headlines for all the right (and wrong) reasons. Global initiatives to reduce carbon emissions are resulting in local actions to support the continued development of renewable energy and drive toward greater electrification in the future.
‘Meanwhile, significant capital is being spent to mitigate the effects of climate change and adapt networks and infrastructure to cope with more volatile climatic events (such as ice storms and wildfires), increase the efficiency of infrastructure (development of electricity storage) and reduce wastage (leaking pipes in water networks). This is driving near-record rate base growth across the sector.
‘We expect infrastructure to be the centrepiece of several governments’ desires to stimulate their economies with the building of infrastructure utilizing local labour, local materials and improving the efficiency of local economies. The US election campaign will likely see “green” infrastructure programs gain momentum.’
Global economy – Brandywine Global (Anujeet Sareen, Portfolio Manager)
‘In 2020, we believe consumer optimism and strong household fundamentals could lead business confidence higher. In particular, the US consumer could determine whether the domestic economy emerges from a mid-cycle slowdown or heads toward a recession that could spread to the rest of the world.
‘Most central banks joined the G3 in 2019 by easing monetary conditions, a trend that should persist in 2020. The tailwinds of easier monetary conditions should transmit into global economic activity in 2020 and eventually push global manufacturing Purchasing Manager Indices (PMIs) higher. While global PMIs have hovered at that crucial “50” mark, emerging market manufacturing and services PMIs have remained expansionary in 2019, helping that broader metric stay in neutral territory. We expect emerging market PMIs will remain strong in 2020 and lend support to developed markets. Similarly, strength from the services sector of the global economy could also offset the slowdown in manufacturing.
‘A faint global macro pulse has started to revive the world economy. For example, consumer confidence remains high, Asian export volume continues to rebound, emerging market PMIs remain expansionary, central banks are easing in concert, and government budgets are accounting for fiscal stimulus. While these factors should bode well for the global economy, the onus will nevertheless be on the US and China to rein in those risk factors that precipitated the broad-based slowdown that started in 2018. We will need to see credible progress in terms of a trade deal, and sound policymaking from the Fed and Chinese authorities. If these factors were to crystallize, we expect that cyclical inflation pressures would remain controlled, US economic growth would level off around 2% and Chinese economic growth would rebound.’
International equities – Martin Currie (Kim Catechis, Head of Investment Strategy)
‘The UK is now looking very likely to exit the European Union at the end of January with a withdrawal deal in place. Brexit certainty should bring with it a relief surge of economic activity, leading to European macroeconomic indicators bottoming out and rebounding particularly the manufacturing PMIs.
‘Sectors such as autos, insurance and capital goods could do well as a result. We should also see some better performance from those companies with a UK domestic focus as many are trading at appealing valuations versus their own history. But we do need to see a resurgence in capital investment in Europe to ensure that productivity and corporate earnings rebound to drive stocks higher over the longer term. Some fiscal stimulus may be required by countries such as Germany, which currently find themselves bogged down in a technical recession.
‘We believe many emerging market economies will see an uptick in growth in 2020. In some cases, such as Russia, South Africa and Turkey this represents a rebound after years of subdued growth. In most emerging economies, however, growth has remained intact and should expand further on the back of widespread interest rate cuts made throughout 2019.’
‘The UK general election may help break the Brexit deadlock and therefore create a material investment opportunity. This relies on the composition of the next government: for equities, the best result is a decent Conservative majority. Under this scenario we would expect UK domestic stocks to materially outperform as the new government takes fiscal action to stimulate the economy, corporate investment levels improve as uncertainty is removed and risk premiums fall. The more complex the general election result, the more likely that Brexit will be delayed, Sterling will weaken, and the FTSE will materially outperform domestic equities.
‘2019, like 2017, has seen unusually low market volatility. With central banks coming to an end of their rate cutting, we are likely to see a return to higher levels of volatility.’
Asia and Emerging Markets
‘In Asia we view the bottoming of earnings expectations, coinciding with basing-out of global PMI data, as near-term market catalysts. Valuations, especially asset-based metrics, are supportive. The ratio of earnings upgrades to downgrades in Asia has been exhibiting signs of stabilisation and may have already bottomed – any modest improvement in the underlying business environment will filter swiftly into this ratio and drive stock prices higher.
‘We expect emerging market investors will look to secular growth sectors such as healthcare, education, cloud computing and clean energy as sources of relative strength within the asset class.
‘Although emerging markets have reduced interest rates by a cumulative 1000 basis points over the last year, there is a lot of room to move. These countries are growing at a fair clip, even though they are not fulfilling their potential. Over the last three years, the U.S. and China contributed 52 percent to global growth. The next biggest contributor is the European Union, which is investing in big scale infrastructure to do green energy.’
‘At a regional level, China’s policy objectives in recent years have been as much focused on the sustainability and quality of economic output as they have been the absolute level of growth. We expect this trend to continue in 2020 and would not be surprised to see growth slip below 6%. This still leaves China as one of the highest-growth economies and we believe Chinese equities will continue to attract increasing interest from global investors. Of particular note, China is implementing corporate bankruptcy policies that are very recognizable to western investors.
‘India is introducing far-reaching labour reform policies; this is a necessary condition for India’s emergence as a regional manufacturing powerhouse. Enactment of these policies is not guaranteed, but they could be attractive for global manufacturers while also reducing costs for local manufacturers and creating the right incentives for smaller companies to scale up. All of this would enable more workers to enter the formal economy.
‘Brazil looks well placed to drive through pension reform, a keystone in building future confidence in the country’s public finances.’