Multi-Asset

5 Trends Likely to Impact Your Clients’ Portfolios in 2020

Fred Demers takes us behind the Global Investment Forum to help Advisors allocate their clients’ assets more effectively over the medium term.
December 2019

Fred Demers

Director, Multi-Asset Solutions

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Once a year, our brain trust gathers at the Global Investment Forum to tune out the daily noise of financial markets in favour of broader themes – political, social and economic – that are currently driving global investment outcomes.

Fred Demers, Director, Multi-Asset Solutions, brings us into the room for those critical discussions, adding his own insightful commentary to help Advisors allocate their clients’ assets more effectively over the medium term.

An overview of seismic changes

What’s next? As the global economy rounds off a historic 10-year expansion, this is the question on many, if not most, investors’ minds. Overall, we find the economic outlook is generally dimmer than in the past decade, though its condition is more positive than commonly understood.

A satisfactory conclusion to ongoing concerns – such as an end to the U.S.-China trade war – could, in fact, prolong the bull market, pushing out the late cycle by months or even years. However, beyond the near term, our team has identified five critical developments which will impact investment strategy and portfolio construction in the new environment: 

  1. De-globalization
  2. Political impact
  3. Slowing gross domestic product (GDP) growth
  4. Weak monetary policy
  5. Climate change

1. A retreat from globalism

Once considered the essential ingredient for long-term growth and prosperity, globalization has now become a dirty word. Populists across the political spectrum have begun pushing back against what they view as the source of rising inequality, increased corporate misbehavior and centralization of power.

While much of this is symptomatic of the Trump presidency, some warning signs actually emerged much earlier. Trade openness measures peaked in 2008, indicating that sensitivity has been growing for nearly a decade, and recent tensions from Brexit to NAFTA renegotiations are simply in line with longer term trends.

5 Trends Likely to Impact Your Clients Portfolios in 2020 - Chart 1

Source: Bloomberg, BMO Global Asset Management.

The challenge now is to reduce risk, while maintaining broad geographic exposure. Unlike in the 1990s when correlation was low across emerging and developed markets, the current tensions have not weakened cross-border financial linkages. Integration is still very high, and going forward it may be difficult to add regional diversification while also lowering your clients’ overall beta.

With the presidential cycle in full swing, Mr. Trump has every incentive to secure a phase one agreement.

2. An ongoing link between markets and politics

Though the retreat from globalism appears to have staying power, a conclusion to near term political issues could ultimately have significant near-term impacts.

Consider the U.S.-China trade war: with the presidential cycle in full swing, Mr. Trump has every incentive to secure a phase one agreement. Rolling back even a portion of tariffs would likely raise investor sentiment, re-accelerate growth and unlock higher gains for equities, thus strengthening an economy which was set to slow in the next two quarters. History shows us that re-election campaigns are easier to win in a robust environment, so coming out with a resolution would undoubtedly help the President’s chances of getting a second term in the White House.

A big latent risk is who will be the opposing candidate. The spectrum of ideas has been extremely wide on the Democratic Party side, especially with Michael Bloomberg entering the race. The tone has been quite unusual – from breaking up tech giants to taxing the rich, there is a surprisingly socialist flavour for modern U.S. politics. That said, it is often the case that elected officials campaign to the left and govern to the middle. 

The consensus view is that global output will decelerate over the next five years.

Meanwhile, across the pond the path forward on Brexit remains highly uncertain. We certainly think the two sides are closer to a deal, yet the upcoming election is between two parties with very different economic agendas – and is up for grabs. Victory on either side could have profound implications for the future of the country. The result: a slowdown of business investment, as firms trying to engage with the rest of the world remain unsure about their relationships with suppliers and customers.

Though Brexit has already created some permanent losses, removing the overhang of uncertainty would not only be positive for the UK, but also Europe and the world in general. It ranks second to the U.S.-China trade war in terms of risk factors. Of course the coup de grâce would be progress on both fronts, so that businesses can regain clarity about the future and begin making investment decisions; however, the consensus view is that global output will decelerate over the next five years.

3. A slowdown in global growth

Some presenters at the Forum pointed to Germany as a warning sign. They argued the country’s flagship auto sector, which exported four million vehicles in 2018 despite its fuel emissions scandal, is deeply vulnerable as consumers switch to electric cars. Batteries used in these vehicles make up approximately 30% of the total production cost and domestic manufacturers would have to go overseas, breaking the country’s long held advantage of regional supply chains and possibly undermining its dominance in the eurozone.

I personally believe the trend is more cyclical than secular. Part of Germany’s slowdown is due to its reluctance to accept higher fiscal spending on the back of negative interest rates. Case in point: the Merkel government sustained a budget surplus as the economy slid towards a technical recession last summer. It will be a tough balancing act going forward, but the focus on a long-term policy agenda should ultimately keep Germany as the strong house in Europe.

The Canadian economy has been similarly underwhelming in the past year, though unlike the rest of the world – U.S. and Europe – our slowdown was mostly domestically engineered through higher interest rates and macro prudential measures designed to slow down the housing market. The last big drag was the Alberta oil production containment meant to address the petroleum supply glut.

The loonie is one of the best-performing currencies this year, which is a show of Canada’s strength vis-à-vis the rest of the world.

All of these factors arrived almost simultaneously to create a near recessionary environment in the fourth quarter of 2018. But then we came out this summer quite strong. The housing market started coming back. Interest rates began dropping, especially for mortgage rates. And while we haven’t seen any rate cuts by the Bank of Canada, the five-year mortgage rate has gone down by roughly 100 basis points since the peak of last year, making it a very different environment from late last year.

It’s still not going to be easy to find growth here, because the rest of the world is slowing and that will have some impact. But the domestic resiliency in manufacturing demonstrates Canada’s economy is not levered to global trade as much as prior to 2008. Put another way, our outlook may not be great, but it’s better than nearly everywhere else.

The loonie is also one of the best-performing currencies this year, having become a safe haven from tariff uncertainty because of Canada’s strength vis-à-vis the rest of the world – and because it is not much a potential target, having already gone through a NAFTA re-negotiation. Looking ahead the most important signal is a rebooting of confidence through trade optimism.

4. Less impactful monetary policy

This past summer the U.S. yield curve inverted for the first time in more than a decade. The indicator – which has historically preceded a recession – suggests a significant slowdown lies ahead, however as overnight borrowing rates started to rise the Federal Reserve (the Fed) started purchasing shorter-term Treasuries to increase the monetary supply. While the program succeeded in steepening the curve, it also increased the Fed’s balance sheet to $4 trillion from $3.8 trillion and stoked fears that the economy may be running out of steam.

USA Yield Curves: Today vs 3 Months Ago

Source: Bloomberg.

Though this has been a very strong signal in the U.S., elsewhere it hasn’t. I find it interesting that Canada has had the most deeply inverted yield curve in the G10, especially given that Italy has had the steepest. If you interpret those figures as signals of economic strength, it would imply Canada is lagging behind Italy. Yet from a fundamentals perspective the Italian economy is still in a very fragile state, having come out of recession earlier this year, whereas Canada continues to have a robust labour market and housing sector relative to its peers.  

Also, central banks in North America – where interest rates are still decently positive – still have room to maneuver toward the zero lower bound and perhaps use quantitative easing, unlike those in Japan and Europe, which are deep into negative territory and have only a fraction of the dry powder usually required to stave off a downturn. This monetary policy gap is one reason we feel the next phase of the cycle could be less severe in Canada and the U.S. than elsewhere.

Many younger Canadians are looking to redefine business, investment and public policy objectives to include a focus on sustainability issues.

5. The shift to de-carbonization

The final trend we discussed was how markets will be impacted by climate action. As nations strive to fulfill goals laid out in the Paris Climate agreement, aiming for net zero carbon emissions by 2050 will require a radical transformation of our food, energy and transport systems.

The clearest pathway is in the electricity generation sector, where good alternatives to coal and natural gas already exist. Though many renewables relied on government incentives in the past, cost reductions have occurred so naturally – and so dramatically – that it’s now possible to access alternative sources of energy at competitive rates without any subsidies at all. For example, the UK’s latest offshore wind auction saw some prices below those offered by the country’s newest nuclear power station.

Support for the transitions is sweeping; France, Sweden and the UK are among the countries that have committed to full de-carbonization, and joining them are some of the Fortune 500’s biggest names, including Amazon.com, Daimler and Duke Energy. Closer to home, we find that many younger Canadians are looking to redefine business, investment and public policy objectives to include a focus on sustainability issues.

On the institutional side we’ve already seen some pension funds divest away from industries with low Environmental, Social and Governance (ESG) scores to take a positive approach to responsible investing (RI), while at the same time we’ve seen ordinary Canadians demand greater input on how their dollars impact the world from a social perspective. The bottom line is ESG is not going away. 

Conclusions for asset allocation

Despite a more sombre economic portrait, the consensus at the Forum was that the current economic cycle has more runway left and that fears of an imminent recession were overdone. Consequently, our asset allocation preferences for the medium term are as follows:

Underweight Underweight Overweight

European equities

  • Volatile geopolitics
  • Weakening activity
  • Lower bond yields

Government bonds

  • Muted inflation
  • Dovish monetary policy

* Within asset class we are overweight on U.S. 10-year Treasuries, underweight on Canadian 10-year rates

Global equities

  • Supportive monetary/fiscal policy to continue
  • Good earnings momentum

* Within the asset class, a focus on U.S. large caps and Canadian equities

U.S. high yield bonds

  • High valuations
  • Concerns about leverage and structural weakness in specific areas like retail

Credit

  • High valuations; considered too expensive currently
  • Relatively illiquid relative to equities from same issuers

Emerging markets soverign debt

  • Low global inflation
  • Dovish central banks
  • Attractive valuations relative to developed markets corporates

UK equities

  • Lingering Brexit uncertainty
  • Devalued pound sterling

U.S. equities

Read our full report from the Global Investment Forum for more insightful market commentary, or contact your BMO Regional Sales Representative to learn about our unique investment solutions and innovative business-building ideas.

 

Also in the December 2019 Issue of Insights:

Standing the Test of Time: How to Build on Success >

How to Meaningfully Integrate Philanthropy into Your Practice >

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

This article is for information purposes. The information contained herein is not, and should not be construed as, investment advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

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