Foresight October 2020: key macro themes and market outlook

The more things change, the more they stay the same—a saying that seems particularly apt as we stand at the precipice of another COVID-19 outbreak. Once again, we find ourselves thinking about lockdowns, social distancing measures, and vaccines.

That said, it’s equally important to remember that progress has been made in the past few months, both on the economic front—thanks to prompt policy response from central banks and national governments—and from a medical research perspective. Although the recovery has slowed and uncertainty is likely to continue to feature prominently in the short term, we believe the worst of the COVID-19 economic shock and the ensuing recession risk is behind us.

From an investment perspective, however, it does mean that a theme that we’re all familiar with is back in play: the search for yield. As interest rates remain low, investors and asset allocators are increasingly pushed toward assets that sit further out on the risk spectrum than were historically required, in exchange for returns.

Volatility across global markets is certainly present; however, we believe investors should continue to push into equities from a return-seeking perspective. Similarly, it’s also important to note that we remain in the recovery phase of the broader economic cycle.  We do believe we’ll see higher equity price levels in the coming year, although the journey isn’t likely to resemble a linear move in price levels. Uncertainty may abound, but wearing our asset allocator’s hat, we’re confident that a sharp focus on macro themes and detailed modeling can point the way to opportunities and highlight emerging risks—just like they used to. 

Short-term macroeconomic themes

• The worst of the COVID-19 shock and recession is likely behind us, although there are continuing risks to the recovery, and we continue to operate in an environment defined by extraordinary uncertainty. While the first phase of the global economic recovery has been encouraging, we expect momentum to slow over the coming 6 to 12 months as a second wave of the outbreak flares, social distancing measures limit a full resumption of activity in the global services sector, and rising geopolitical risks in many pockets of the world look set to heighten the level of uncertainty for businesses and households alike.
• The recovery remains uneven and is likely to resemble the letter K in which some sectors recover rapidly while others stall or slip back into recession-like circumstances. Broadly speaking, we expect to see this divide take place between manufacturing—which continues to recover extremely quickly—and services—which remains mired in COVID-19-related complications. This atypical recession/recovery environment implies that companies and countries more leveraged to manufacturing (e.g., industrials, Asia) should outperform those that are more leveraged to the services sector (e.g., retail, U.S.).
• Monetary and fiscal policy has substantially dampened the impact of the pandemic to both the global economy and financial markets. We expect most major central banks to engage in further easing, although for most of them, this will involve little more than tinkering with existing tools as opposed to implementing additional rate cuts; however, we expect central banks to respond forcefully to any sharp increase in yields—this should ultimately keep global government bond yields trading within a narrower range than what we’ve seen historically. We believe they’ll continue to focus on providing ample liquidity to the market and work hard to prevent a financial crisis from materializing.
• We’re at a point where markets are more likely to be focused on fiscal policy as a driver of current and future growth. We expect government spending to continue, despite already being at historically high levels, even in the United States. We expect fiscal policy to become an increasingly important driver of inflation expectations and the long end of the yield curve in most countries.
• Investor uncertainty remains high and cautiousness is widely prevalent. This is evidenced by market participants’ bafflement at the elevated valuations of risk assets, the high levels of cash holdings, outflows from equities, and tepid investor sentiment. Risk assets have the tendency to climb walls of worry, and there’s plenty to worry about at the moment. We believe we’re still in the recovery phase of this cycle, and risk assets have more room to run in the coming year, albeit at a more moderate pace. We could see more support for risk assets with the U.S. election in the rearview mirror, where the potential for more monetary and fiscal support and prospects for further medical advancements through vaccines and/or therapeutics for COVID-19 come into view. 

• We don’t expect any major central bank to raise interest rates in the next five years; however, we concede that there could be attempts to normalize monetary policy through slimming down central bank balance sheets in a few years’ time. This implies investors will need to get used to the idea that interest rates will likely stay at, or below, 0% for the foreseeable future. This should usher in another period in which search for yield becomes a key market theme, pushing investors further out on the risk spectrum in exchange for meaningful returns. As such, we continue to favor asset classes that provide positive carry, and emerging-market debt stands out as one of the more appealing asset classes. 
• While we continue to incorporate the structurally deflationary impulses of an ageing demographic, rising debt, and ongoing digitalization into our forecast, we also recognize that the combined impact of substantial monetary and fiscal easing—not to mention a global supply-side shock—will likely generate higher inflation expectations. Even as central banks keep short rates well anchored and are unlikely to respond to these inflationary pressures (assuming they remain mild or moderate), the yield curve is likely to steepen at the long end over the next five years.  
• We expect the U.S. dollar to soften over the next few years. The U.S. Federal Reserve’s (Fed’s) efforts to improve U.S. dollar (USD) liquidity should, in our view, help address the dollar shortage issue and contribute to the currency’s gradual weakening over time. From an investment perspective, a weaker greenback should provide some mild to moderate support to emerging-market (EM) assets and select developed-market (DM) equities and fixed income. 
• China—and, by extension, Asia—is likely to benefit from a relative strengthening of the global manufacturing and trade environment. We continue to expect economic growth in China to structurally decelerate over the multi-year horizon as it moves toward a consumer growth model.  Policy response to COVID-19 should be meaningful enough to keep the deceleration in China gradual.  Outside of China, we expect EM to maintain an attractive valuation profile, benefiting from a global cyclical upswing/rebound, aided by a structurally weaker USD. 

Index definitions

Cambridge Associates LLC Infrastructure Index

The Cambridge Associates LLC Infrastructure Index is a horizon calculation of 93 infrastructure funds, including fully liquidated partnerships, formed between 1993 and 2015.

MSCI/REALPAC Canada Quarterly Property Fund Index
The MSCI/REALPAC Canada Quarterly Property Fund Index tracks unlisted open-end real estate funds operating in Canada and measures the investment performance at the property and fund levels. 

NCREIF Farmland Index

The NCREIF Farmland Index is a quarterly time series composite return measure of investment performance of a large pool of individual farmland properties acquired in the private market for investment purposes only.

NCREIF Timberland Index                                                                                
The NCREIF Timberland Index is a quarterly time series composite return measure of investment performance of a large pool of individual U.S. timber properties acquired in the private market for investment purposes only.

NFI–ODCE
The NCREIF Fund Index–Open-End Diversified Core Equity (NFI–ODCE) is a fund-level capitalization-weighted, time-weighted return index that includes property investments at ownership share, cash balances, and leverage.It is not possible to invest directly in an index.