Foresight April 2020: key macro themes and market outlook

The first few months of the year were dominated by COVID-19—a term that few had heard of coming into 2020. The world was ill prepared for the impact and scale of this pandemic, which has led to lockdowns and a still to be determined impact to global growth. The business of forecasting—difficult enough to get right in the best of times—became even more challenging in this climate, as containment efforts rendered traditional month-over-month and year-over-year comparisons largely meaningless, apart from crystalizing the fact that a significant economic contraction is already under way.

That said, as long-term investors who have navigated many episodes of stress, including the global financial crisis of 2007/2008 and the European sovereign debt crisis, we know that this too shall pass. Indeed, as of this writing, there are suggestions that the outbreak in several countries could have peaked, and that the global race to develop effective treatments and vaccines is in an advanced stage. Policy actions across the globe, both in terms of monetary and fiscal stimulus packages, should cushion the economic damage and pave the road to recovery.

As we’ve noted previously, history has shown us that a sharp market correction is usually followed by a rebound of a similar—if not greater—magnitude that unfolds over the following years, and the volatility of investment returns typically normalizes over time. While the seemingly endless stream of breaking news might tempt us into assessing everything through the prism of now, we believe it’s important for investors with longer investment horizons to retain a strategic view: The short-term view may be gloomy, but it doesn’t mean that the dark clouds will be a permanent feature of the picture.

It’s through this lens that we formulate our return forecasts for the various asset classes over the next five years. Our forecasts are derived from a wide number of sources, including input from our macroeconomic strategists who are embedded within the asset allocation team. While our long-term forecasts lean heavily on model-based valuation estimates, we believe that macroeconomic views play an important role in navigating evolving market conditions and in identifying short-term investment opportunities.

Short-term macroeconomic themes

• We expect the COVID-19 shock to create the sharpest global economic contraction since the 1950s; however, we also believe the contraction will occur within a compressed timeframe and will be front loaded in nature. Unlike most past global recessions, the coming recession will be services led as opposed to manufacturing led, which will likely result in larger job losses.
• While the contraction is likely to be the largest in modern economic history, we also expect the United States—and the global economy—to bounce back in the second half of the year. In our view, global markets will be more focused on the timing and the speed of the economic recovery than the weakness witnessed in Q2, which many will perceive as transitory. Although we harbor some concerns that the rebound is more likely to be delayed than arrive early, we believe a meaningful re-acceleration seems reasonable by year end.
• Aggressive central bank action has reduced the likelihood of a credit crisis, although risks remain and should be closely monitored. We don’t expect the U.S. Federal Reserve (Fed) to pursue negative interest rates, but we believe that short-term interest rates will remain anchored at low levels for a multi-year period.
• Announced fiscal measures are significant and we believe that they’ll be more effective at supporting the recovery as opposed to preventing an economic contraction from taking place in Q2. We believe this amount of global fiscal support will be a catalyst to increased inflation in the medium term and is likely to steepen the yield curve.
• The recent sharp decline in oil prices is causing additional disruptions in the global economy and financial system. We believe this will be a more significant drag on global growth and markets than consensus currently recognizes.
• Absent a second wave of the virus outbreak, we’re likely to see improvements in economic data out of Asia in the short term (even though the region will need to manage several long-term implications arising from the changes that occurred as a result of the outbreak). Meanwhile, we believe several developed markets with high levels of household debt (such as Australia and Canada) are at risk of experiencing a large-scale deleveraging, which could have negative implications for the residential real estate sector.

Longer-term strategic views  

• With markets significantly off their early Q1 highs, our return expectations, particularly within equity markets, have increased since our last publication. Although stock prices have fallen, valuations are far from inexpensive —in many cases, a lot closer to fair value, in our view. Furthermore, as we expect some re-expansion, investors are likely going to need to be willing to accept higher levels of volatility in the equity markets in order to achieve more robust returns.
• Within fixed income, our expectations for government bonds remain in the low single digits across the globe. We see credit—both investment grade (IG) and non-IG—as being a quite attractive alternative and the risk more moderate in relation to equities. 
• We expect the extraordinary easing measures announced by global central banks in the first quarter of 2020—including a return to the effective lower bound of central bank policy rates—to be maintained for several years. Indeed, we don’t expect global central banks to be able to raise interest rates over the next five years, as key conditions for higher interest rates are unlikely to be met.
• We’ve long believed that search for yield is a key investment theme that will dominate the financial markets. It’s now likely to be even more prominent in the midst of extremely low interest rates. We continue to favor asset classes that provide positive carry, such as emerging-market (EM) debt. 
• We believe the economic shock brought about by the COVID-19 outbreak will likely be deflationary in the near term but the combination of substantial monetary and fiscal packages will likely generate higher inflation expectations in the medium term. This is likely to lead to steeper global yield curves over the five-year forecast horizon. This represents a change in our view—prior to the outbreak, we believed that the curve would remain fairly flat over the strategic horizon.
• We believe U.S. dollar (USD) strength is approaching its peak and expect the currency to weaken over the forecast horizon. The Fed’s efforts to address issues relating to the global shortage of the USD (and therefore USD liquidity) should also curb the currency’s strength. A weaker greenback should provide some mild to moderate support to several key non-U.S. asset classes such as EMs and other developed-market equities and bonds. 
• Growth in China, the world’s second-largest economy, is likely to continue to structurally decelerate, creating downside pressure on global trade activity on a long-term basis and weigh on global manufacturing activity. In our view, the combination of rising global tariffs and the shutting of borders—in the midst of COVID-19—will reduce globalization efforts and threaten global supply chains. That said, for both valuation and carry reasons, we continue to view EMs favorably over our forecast horizon.

Cambridge Associates LLC Infrastructure Index
The Cambridge Associates LLC Infrastructure Index is a horizon calculation based on data compiled from 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. The index measures the investment performance at the property and fund level. 

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.