FIXED INCOME MARKET VIEWS*
The AAC’s maintains its positive view on credit and inflation protected securities over nominal Treasuries, and increasingly favors emerging markets.
Investment Grade Fixed Income
The Asset Allocation Committee (the “AAC” or the “Committee”) moved to an underweight view on U.S. Treasuries while maintaining a positive view on investment grade credit.
- Sovereign bond yields are low and credit spreads remain tight, while interest rate exposure could be a risk in the event that global risk appetite continues to recover.
Treasury Inflation Protected Securities
The Committee maintained an overweight view.
- Treasury Inflation-Protected Securities (TIPS) pricing remains subdued despite relatively strong realized inflation.
- Stable realized inflation combined with accommodative central banks may fuel outperformance.
Developed Market Non-U.S. Debt
The Committee maintained its strong underweight view.
- While Europe has steeper yield curves and there is some benefit from hedging currency exposures for U.S. dollar investors, overall rates in Europe and Japan are still well below those in the U.S.
- The new ECB President, Christine Lagarde, signaled policy continuity for the time being, which includes a fresh round of open-ended stimulus launched in September 2019.
- Nonetheless, European ultrashort cash and euro opportunistic approaches are likely to garner interest as investors seek positive yields in European high-quality fixed income.
High Yield Fixed Income
The Committee maintained its overweight view.
- While CCCs represent poor upside given risks, higher-quality BB rated high yield debt appears attractively valued.
- Supply-and-demand imbalances in floating rate loans and collateralized loan obligations (CLOs) may make them attractive places to take credit spread risk.
Emerging Markets Debt
The Committee moved back to an overweight view.
- Agreement on phase one of a China-U.S. trade deal should help consolidate stabilization in manufacturing and trade worldwide, and a growing growth gap between the emerging and developed worlds tends to favor emerging markets debt and currencies.
- The potential for a weaker U.S. dollar later in 2020 would add another tailwind.
EQUITY MARKET VIEWS*
The AAC has shifted its preference to non-U.S. markets, where it sees more cyclical exposure to an anticipated upturn in global sentiment.
The Committee moved back to an underweight view on U.S. large caps and downgraded U.S. small and mid caps to a neutral view.
- While the AAC believes that U.S. GDP growth will be 2.0% or better in 2020, potentially feeding into mid- to high-single-digit earnings growth, that would still require a forward earnings multiple in excess of 20-times to generate a 10% total return in 2020—which is possible, but not our central scenario.
- While the index-level multiple may not move very much, we do see potential for higher returns in more cyclical parts of the market.
- Other global markets have more potential for multiple expansion and higher operating leverage than U.S. equities.
- Impeachment and the November elections could raise U.S. political risk.
Public Real Estate
The Committee maintained its underweight view.
- The long-term growth prospects of increasingly important alternative sub-sectors such as datacenters, cellular towers and single-family rentals remain intact.
- Nonetheless, Real Estate Investment Trusts (REITs) rallied strongly during 2019, and a rotation into more cyclical sectors could hurt more defensive sub-sectors.
Non-U.S. Developed Market Equities
The Committee moved from an underweight to an overweight view.
The Committee retained its neutral view on European equities.
- Employment, credit growth and consumer confidence remain robust, the European Central Bank remains accommodative, and an easing of U.S.-China trade tensions and stabilizing manufacturing data would benefit the region.
- Nonetheless, the Committee needs to see more willingness to apply fiscal stimulus before upgrading its view in line with other non-U.S. markets.
The AAC retained an overweight view on Japan, given robust consumer confidence and continuing loose policy at the BoJ—an easing of U.S.-China trade tensions and stabilizing manufacturing data would also benefit Japan.
- A consumption tax increase is due in October: this has historically dampened growth for a quarter, but the government is prepared to provide stimulus to reduce the impact.
- Now that the Conservative party has a large majority in the House of Commons, the U.K. will be able to move ahead with Brexit and begin its trade negotiations with the European Union.
- The removal of a lot of uncertainty from the process has led to an immediate improvement in business sentiment.
- The new government is also preparing a meaningful fiscal stimulus, particularly in those parts of the country that have been won over to the Conservative party for the first time.
Emerging Markets Equities
The Committee moved back to an overweight view.
- An easing of U.S.-China trade tensions and stabilizing manufacturing data would benefit emerging markets, and there is still scope for multiple expansion here.
- A growing growth gap between the emerging and developed worlds could favor emerging markets.
- Operating leverage, which tends to be higher in emerging markets, is likely to be a tailwind in 2020 as earnings recover worldwide.
REAL AND ALTERNATIVE ASSET MARKET VIEWS*
The AAC favors directional hedged strategies and private equity as it seeks marginal economic sensitivity in its view on alternatives.
The Committee maintained a neutral view.
- Stabilization in global growth and manufacturing has the potential to provide a tailwind for commodities in 2020.
- Gold and oil may serve as hedges against geopolitical shocks in the coming year.
The Committee downgraded its view on lower-volatility hedged strategies to neutral, but maintained its overweight view on directional hedged strategies.
- While lower-volatility strategies are attractive relative to low yields in traditional fixed income, they will play a lesser role in portfolios should appetite for risk continue to improve.
- Because directional hedged strategies retain some market exposure, they remain an attractive allocation as appetite for risk turns cautiously optimistic.
The Committee retained its overweight view.
- The AAC continues to favor a consistent, strategic and disciplined investment plan in private markets.
- Valuations appear full and covenants in debt packages are weaker in private markets, which argues for selectivity.
- Nonetheless, valuations are also stretched in public markets, and private markets offer more opportunity to create value postpurchase, through operational improvements within portfolio companies, making it one of the AAC’s preferred destinations for marginal equity dollars
The AAC moved from an underweight to a neutral view.
- Market participants remain long the dollar despite it being overvalued on a purchasing power parity (PPP) basis, a closing growth gap with the rest of the world and a twin deficit.
- The Federal Reserve is likely to remain accommodative and balance sheet expansion is dollar-negative on the margin.
- Impeachment and the November elections raises U.S. political risk.
- Risks to the view include support from the (albeit closing) growth gap and the (albeit narrowing) short-term interest rate differentials.
The AAC maintained its underweight view.
- The large negative carry already discourages long positions and the ECB has recently adopted a still more dovish stance.
- European Purchasing Managers’ Indices have improved, but are still weak.
- While there has been progress on trade with China, the U.S. has still not properly addressed the proposed tariffs on European autos.
- Scandinavian currencies are undervalued versus the euro.
- Risks to the view include: the euro zone’s large current account surplus; any signs of recovery in global growth or local fiscal stimulus, from which the euro zone would likely benefit; the market’s already short position; and the currency’s undervaluation on PPP measures.
The AAC maintained its overweight view.
- Japan runs a current account surplus.
- Long yen remains attractive during periods of risk aversion and both PPP and real exchange rates suggest the JPY is undervalued.
- Japanese growth continues to be strong, supported by new fiscal stimulus, while extremely low unemployment should support inflation.
- The recent collapse in global bond yields makes Japan’s low yields less discouraging.
- Risks to the view include: the still-wide yield differentials in both nominal and real terms with the U.S., exacerbated by the BoJ yield curve-targeting policy; an ongoing rebound in risk sentiment; and market participants still holding a slightly long position in the currency.
The AAC moved to a neutral view.
- The GBP appears undervalued based on PPP measures.
- Brexit uncertainty has lifted for the time being, as the Conservative party achieved a large parliamentary majority in December’s general election.
- U.K. job creation and wages have been stronger than expected and consumption activity has remained remarkably healthy.
- The Bank of England (BoE) is unlikely to make a move in either direction until there is further data on sentiment and inflation following the U.K.’s likely departure from the European Union at the end of January.
- Risks to the view include rising political uncertainty as the U.K. embarks on trade negotiations with the European Union; evidence from the U.K.’s trade balance that GBP weakness is not boosting exports as much as expected; easing wage pressures; and any sign that pre-election weakness in business sentiment is persisting into 2020.
The AAC maintained its underweight view.
- The CHF still appears very overvalued based on PPP measures.
- Policy action by the SNB is underpriced and the persistent strength of the currency continues to keep inflation low.
- The CHF is one of the most attractive funding currencies and carry is likely to be in favor in current market environment.
- Risks to the view include: Switzerland’s current account surplus; the potential for Switzerland to benefit from improvements in European growth; and the likelihood that the Swiss National Bank will be cautious about currency intervention in the run-up to a U.S.-Switzerland trade deal.
UP FOR DEBATE
Will U.S. Capex Recover In 2020?
For U.S. large caps, the difference between 5 – 7% earnings growth and 8 – 10% earnings growth in 2020 is likely to be determined by how much investment companies make. A lack of capital expenditure has dragged on the economy for two years, during which time the consumer, emboldened by low unemployment and interest rates, has kept corporate America going.
To invest, business managers need to have confidence. What has been weighing on confidence? Political uncertainty and— especially—uncertainty over global trade.
With some of that global political risk abating, U.S. business leaders will now focus on the domestic scene as they head into an election campaign. Can we hope for enough certainty to release pent-up investment before the results are known in November?
Some on the Committee were doubtful. When you’re planning 10-year corporate investments, the argument goes, it pays to wait 10 months and know the lay of the land—particularly as the race for the White House looks set to be close.
Others were more optimistic. Should the progressive Democratic candidates lose traction in the polls after “Super Tuesday,” they think CEOs will see little difference between a moderate, more market-friendly Democrat and the White House incumbent. In this scenario, investment may start to pick up in the second half of the year.
Early signals from survey data are encouraging. While CEO confidence measures were plumbing new lows in the third quarter of 2019, the view of the CFOs who will actually make investment decisions have started to brighten. And while inventories built up to face global-trade uncertainty now need to be run down, a trough may have formed in the Institute for Supply Management’s (ISM) manufacturing sector new orders indicator, pointing to a recovery in demand.
It may take some months to pick up momentum, but 2020 could be the year that corporate America starts to spend again.
Can The Euro Zone Loosen Fiscal Policy?
Despite general enthusiasm for equity markets outside the U.S., there was one region that divided opinion on the Committee: the euro zone.
The case for Japanese and U.K. equities rests in part on new fiscal stimulus in Japan and the potential for post-election and post-Brexit stimulus in the U.K., particularly directed to those northern constituencies that switched their votes to the Conservative party in December. The fiscal rules for the euro zone in general and Germany in particular make a similar intervention more difficult.
Some Committee members see little scope for this to change, and therefore less upside potential in European equities.
Others see modest signs of movement. They argue that, as skepticism about the effectiveness of negative interest rates and quantitative easing rises worldwide, the euro zone will be exposed as the region most in need of a handoff from central bank stimulus to government stimulus. There may be signs of movement in Germany, where the Social Democratic party, currently governing in coalition with the Christian Democrats, unexpectedly elected two left-wingers to its leadership late last year. They have already indicated that they could withdraw support for Germany’s commitment to a balanced budget.
When we look at the fiscal balance of the G20 countries, it is clear that Germany and the Netherlands, and even the euro zone as a bloc, are among the world’s most austere economies—which is remarkable given their negative interest rates. How should we interpret that? As a sign of how entrenched fiscal tightness is in these countries? Or as expansive capacity to loosen the purse strings when the time is right? The answer may determine the relative performance of euro zone equities in 2020.
ASSET ALLOCATION COMMITTEE
About the Members
Neuberger Berman’s Asset Allocation Committee meets every quarter to poll its members on their outlook for the next 12 months on each of the asset classes noted and, through debate and discussion, to refine our market outlook. The panel covers the gamut of investments and markets, bringing together diverse industry knowledge, with an average of 28 years of experience.