We believe that the global economic recovery will continue in 2020, although it may have to sidestep substantial risks to sustain momentum. Those risks notwithstanding, renewed monetary policy support and resilience in consumer spending and services should help to propel the cycle forward. We expect world real gross domestic product (GDP) growth to improve modestly in 2020 (see Table). This view rests on an assumption of easing trade tensions; we are closely monitoring developments.
|Real GDP Growth||2018 (%)||2019 (%, projected)||2020 (%, projected)|
Source for 2018 data: National databases. Source for 2019 and 2020 projections: State Street Global Advisors Economics, as of September 16, 2019. Actual performance may differ from these projections.
This 2020 outlook somewhat resembles our 2018 and 2019 outlooks; in each of these years, the global economy managed to expand despite late-cycle worries. As this long cycle matures and risks to the recovery gather, this call becomes more difficult to make. This year, even as some areas of the global economy weaken, we believe that pillars of strength remain to see it through. The only way out of this challenging investment landscape is to move through it, relying on pockets of resiliency and opportunity as we go.
As investors make their way forward and seek to capitalize on these opportunities, many forces – including geopolitical tensions and lingering policy uncertainty – will present difficulties. As the differences between the more resilient areas of the economy and those that are less so become clear, investors’ ability to achieve their desired outcomes will depend on the quality of their decision making; in the absence of a uniformly rising tide, choosing where to invest will matter.
In light of our overall growth forecast, we continue to favor select risk assets. Our emphasis on the selection of risk assets is deliberate; although we believe global GDP growth will come in close to long-term averages, there are considerable regional and sector disparities.
We believe US economic outperformance will continue, although the outperformance gap between the US and other regions may start to shrink. Europe continues to lag due to cyclical and structural problems, but a catalyst could trigger improvement, especially in the second half of 2020. Emerging markets (EM) will be critical contributors to global growth; that said, we expect economic performance in emerging markets to be highly variable. At the sector level, relative strength in services will partly offset relative weakness in manufacturing. Consumer spending will partly offset a slowdown in business investment.
We recognize that there are significant risks to our base case outlook. Capital preservation will be a high priority in 2020; we’re building hedges to address a wide range of geopolitical and policy risks. But the risks to our outlook are not confined to the downside. Upside risks include the possibility that slowing growth could motivate fiscal stimulus in major economies. With that in mind, we’re watching five major areas of uncertainty in the year ahead:
Positive outcomes in many of these areas would likely benefit Europe and emerging markets, which have suffered from years of underperformance, even more than they would benefit the US – which has less room for improvement. As 2020 unfolds and uncertainty in each of these areas moves toward (or away from) resolution, we will issue additional commentary on the implications for investors.
As important as it will be to track these critical areas of uncertainty, we also believe it’s critical for investors to consider world-changing forces that pose substantial portfolio risk, which a one-year outlook may not capture. Climate change is one of these forces. As we look to 2020 and beyond, we believe that regulatory pressure and carbon pricing initiatives are likely to accelerate, impacting asset valuations and capital allocations. This, in turn, will motivate investors to consider and take steps to manage the climate risk embedded in their portfolios and evaluate the investment opportunities that a changing climate-risk landscape will provide.
As EM debt and equity indices expand, emerging market equities and debt are already an increasing part of investors’ portfolios. We expect investors to continue treating EM investment as part of their core allocations. At the same time, we believe that emerging markets equities and debt hold long-term growth and income potential for investors, and that EM investment deserves particular consideration in 2020.
Our current tactical underweight to emerging markets equities reflects a trend of disappointing earnings growth, along with concerns connected to trade tensions and other structural issues. EM earnings improved slightly in the second half of 2019, and consensus next-12-month earnings-per-share growth estimates show some signs of improvement, particularly in trade-related sectors that have been hit hard in recent months (although further escalation in trade tensions does remain a risk).
EM equity valuations are modestly attractive relative to developed markets (DM), but uncertainty persists, particularly with respect to earnings, trade tensions, capital flows and potential structural reforms. Catalysts that might allow investors to realize value in EM equities include:
As we await those catalysts, it’s important to note that currently EM equity returns are relatively widely dispersed; this suggests an opportunity for careful stock selection. Although beta investors with an index-only investment in EM equities might need to see a substantial turnaround in earnings growth to realize their objectives, we believe those seeking to access the EM equity growth story today would benefit from actively managed strategies seeking:
We believe EM debt will continue to present attractive opportunities for both income and total returns in the year to come. More dovish US Federal Reserve and ECB policies are likely to provide flexibility for EM policy makers on both the monetary and fiscal fronts, given the improvements made over recent years on their fiscal and current account balances.
Bond valuations now favor EM versus DM debt. Real yields on DM government bonds are currently negative, while EM real yields are positive and attractive.(1) EM inflation has been trending down consistently over recent years, justifying a lower inflation risk premium. Furthermore, EM currencies are relatively undervalued, creating what could be seen as a reasonably good entry point for investors.
Chinese bonds, particularly government bonds and policy bank bonds, will merit particular consideration because their continued addition to the bond benchmarks, including EM benchmarks in 2020, is likely to result in substantial investor focus and a related increase in flows. Chinese bonds offer both yield and diversification benefits. Chinese bond yields tend to fall between the lower yields of developed markets and the higher yields common in emerging markets, and returns on Chinese bonds have historically displayed relatively low correlation to those in developed markets.