Given elevated market valuations, a sluggish economic backdrop and concern over the corporate earnings outlook versus expectations, our view is that current market levels give little margin for error and we enter 2020 in a cautious frame of mind. In 2019, global growth slowed, and corporate earnings were at best flat (in the US) and elsewhere (Europe, Japan and emerging markets), down just over 10%. In this context, the strength of returns from risk assets in 2019 was even more impressive. Price/earnings ratios re-rated over the year, and now sit close to the 15-year highs seen at the end of 2017. The strong returns are not exclusive to equities; Greek government debt for example yielded almost 35% back in 2011; the same 10-year bonds yielded just under 1.5% at the end of 2019. We would observe that expectations for corporate earnings in 2020 imply a significant acceleration in global economic growth in 2020 to more like 5% – a level never achieved in the decade since the financial crisis. Therefore, we see considerable scope for disappointment, with a lot of good news already priced in, and what we see as over-optimistic assumptions being made for economic and earnings recoveries in 2020.
The pace of the slowdown in the latter months of 2019 may have eased, but having seen significant falls in corporate capital expenditure (i.e. investment) and industrial production globally, the world economy is increasingly reliant on consumers to be the engine of growth. We will therefore be watching employment and consumer related data very closely for signs of any cracks.
We remain happy to be very slightly underweight in equities for now, but with exposure to underlying fund managers who are telling us that despite all the noise, there are plenty of opportunities at the stock picking level. We are also underweight in fixed income – our concerns over bond market dislocations and liquidity are noted in this document and we are focusing on the most flexible, dynamic and liquid funds with managers that are well known to us for an ability to navigate choppy waters. Liquidity is also a concern in the property sector – this is an area where we have found plenty of ideas and are broadly neutral. However, we choose to invest in products where there is no mismatch between daily liquidity and illiquid underlying assets. Hence our exposure to closed-ended property funds or funds that are not marketed to retail investors. We continued to hold slightly above average cash positions, reflecting our caution on current market levels; some of our cash is held in gold as a hedge against number of risks crystallising, be it inflation, political risks or confidence concerns over the central banks. We have some exposure to absolute return funds, again as insurance against a market pullback and heightened volatility.
In terms of regions, it is worth bearing in mind we do not take particularly aggressive views – we believe we will generate more alpha by selecting the right fund managers for the market environment. Furthermore, attempting to second guess macroeconomic and political outcomes in a world of increasing social, economic, environmental and political uncertainty is unlikely to generate significant returns. All the same, we go into 2020 with a neutral exposure to the UK, with a bias towards small and mid-cap managers as well as value investors. Value investing has been a tough environment in the UK and beyond in recent years, but we do see and hear evidence of this style of investing finding more favour. We are slightly underweight in Europe given the pace of economic growth and the fact that European assets had such a strong run in 2019; we see more positive opportunities elsewhere, not least when we look east towards Asia and Japan. We continue to be overweight Japan, where we see continued domestic reforms and shareholder friendly policies along with continued central bank support as a positive backdrop for an equity market that is still relatively good value, and with a more positive earnings outlook than other markets despite tepid economic growth. We also are overweight Asia and emerging markets, where interest rates continue to fall and the growth outlook, assuming a stabilisation in global growth, looks reasonable. We do see risks from China’s economic evolution to a more consumer-led economy but believe the Chinese authorities will continue to take steps to smooth this transition and stimulate the economy to maintain growth around 6% – although we would caution on political factors not least the lingering democracy protests in Hong Kong. We are slightly underweight the US, believing that the outperformance of recent years may be drawing to a close given valuation levels and potential scope for disappointment on what look like very optimistic earnings expectations for 2020.