Foresight | April 2019: key macro themes and market outlook
The last six months have been marked by volatility. Is this trend likely to continue in the foreseeable future? Our asset allocation team shares their short-term and structural views.
We ended 2018 by narrowly escaping a technical bear market in the United States; this year, however, has already produced a double-digit return in most global equity indexes.¹ Central banks have provided much support for both the bond and stock markets—the People’s Bank of China engaged in sizable easing, and most developed-market central banks, including the U.S. Federal Reserve, adopted a dovish tone. That said, investors shouldn’t forget that we’re much closer to the end of the global growth cycle than the beginning, and recession risks will likely remain elevated over the next two to three years.
It’s through this framework 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 those from the team of macroeconomic strategists that’s embedded within the asset allocation team. While our long-term forecasts lean heavily on model-based valuation estimates, we firmly believe that macroeconomic views play an important role in identifying more short-term investment opportunities in actively managed portfolios.
Key macro views
Short-term macroeconomic themes
- Developed-market (DM) central banks, led by the U.S. Federal Reserve (Fed), are likely to have finished hiking interest rates in this cycle. In our view, the next change in interest rate is more likely to be a rate cut than a rate hike. This should keep bond yields relatively well contained globally.
- U.S. growth dynamics are likely to improve in the second and third quarters of 2019 following a difficult first quarter. We continue to view the U.S. consumer as a bright spot, not just within the U.S. economy, but globally. We believe the expected short-term improvement in U.S. growth, along with some mild reflationary pressures beginning in the summer, should provide support for U.S. equities and nudge U.S. yields slightly higher.
- China has engaged in substantial fiscal and monetary stimulus that will, in our view, arrest the deterioration in economic data witnessed throughout 2018. This has lifted investor sentiment toward emerging markets (EM), and should continue to offer a tailwind to Asia in general. However, we don’t believe that the Chinese economy will experience a V-shaped recovery unless the authorities engage in additional stimulus, particularly measures aimed at the property and credit markets.
- After a very difficult 2018, we believe European growth will find a bottom in the second half of this year, supported by more stable growth in China; Europe is also poised to benefit from improved global trade and industrial production activity in the latter part of this year.
- Geopolitical risks (Brexit, U.S.-China trade relations) will continue to weigh on sentiment.
Longer-term strategic views
Based on traditional leading economic indicators, 2020 looks set to be a more difficult year for the U.S. economy, with a small tail risk of recession. However, we expect any weakness to be short-lived and mild relative to past comparisons, with growth resuming toward trend in the latter part of our five-year forecast period. Strategically, this means we favor a modest growth bias in which we can contain risk and take selective opportunities.
We believe the U.S. dollar (USD) is likely to enter a structurally weaker period in the coming five years, largely on the back of growing trade and fiscal deficits. This could provide modest tailwinds to most non-U.S. assets, particularly EM assets, and support global growth through easier financial conditions and reduced financial tightening.
Despite expectations for a mild increase in price levels in the near term, we see little scope for elevated inflation over the coming five years. We expect DM inflation profiles to remain close to or below 2%. This should keep central banks relatively dovish compared with the past several decades, although we do see most policy rates rising in the latter part of our forecast period as central banks continue to pursue some degree of normalization.
We expect economic growth in China to continue to decelerate on a structural basis as the economy transitions away from manufacturing and toward services. That said, we believe EM debt and equities will remain attractive, thanks to valuation and carry.
Index definitions
NCREIF Farmland Index
The NCREIF Farmland Index is a quarterly index that measures the performance of a large pool of individual U.S. farmland properties acquired in the private market for investment purposes only. The composition of the index can change over time—for example, when assets are sold, and when new Data Contributing members are added. As such, the Farmland Index may not be representative of the agricultural investment market as a whole.
NCREIF Timberland Index
The NCREIF Timberland Index is a 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. It is updated quarterly and is reported on a national level. The index is reported on a national level and is subdivided into three regions: the Pacific Northwest, South and Northeast. The composition of the index can change over time, and as such, may not be representative of the imberland investment market as a whole.
NCREIF Open End Diversified Core Equity ODCE Index
This is a capitalization-weighted, gross of fee, time-weighted return index with an inception date of December 31, 1977. Open-end funds are generally defined as infinite-life vehicles consisting of multiple investors who have the ability to enter or exit the fund on a periodic basis, subject to contribution and/or redemption requests.
MSCI/REALPAC Canada Quarterly Property Fund Index
The MSCI/REALPAC Canada Quarterly Property Fund Index covers unlisted open-end Real Estate funds operating in Canada. The index measures the investment performance at the property and fund level. The index is based on funds with a total net asset value of CAD $32.1 billion as at December 2018.
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. Private indexes are pooled horizon internal rate of return (IRR) calculations, net of fees, expenses, and carried interest.
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