October 30, 2020

Foresight October 2020: key macro themes and market outlook

In recent months, investors have gone from worrying about the impact of interest-rate normalization to seriously thinking about the potential implications of negative interest rates. As we move into the next phase of the COVID-19 outbreak, the search for yield is becoming increasingly urgent.

Good yield hunting: the return

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.

Chart of five-year asset class forecasts, expected returns in U.S. dollar terms, as of September 30, 2020. The asset allocation team’s expected five-year total return for various asset classes are as follows: 3.9% for U.S. large cap; 7.9% for U.S. mid-cap, 6.7% for U.S. small cap; 7.9% for Canadian large cap; 8.6% for large cap equities in Europe, Africa and the Far East (also known as EAFE); 8.7% for EAFE small cap; 5.5% for global large cape; 7.8% for European equities; 7.3% for Japan equities; 8% for emerging-market equities; 7.8% for emerging Asia equities; 6.6% for U.S. real estate investment trusts, 6% for global infrastructure; 8.4% for global infrastructure; 8.6% for global natural resources; 0.6% for U.S. investment-grade bonds, 3.9% for U.S. high-yield bonds; 3.4% for U.S. leveraged loans; 0.2% for U.S. Treasury inflation-protected security; 5.1% for emerging-market debt; and 0.5% for global government bonds.

Key macro views

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.

Asset allocation team’s six to 12 month allocation view on equities, as of September 30.. The team is moderately positive on U.S. equities, global emerging markets equities, and Chinese equities. It is neutral on Japanese equities and Canadian equities. It has a slightly negative view of European equities. Asset allocation team’s six to 12 month allocation view on fixed-income assets, as of September 30. The team has a moderately underweight stance on U.S. government bonds, European government bonds, Japanese government bonds, and Canadian government bonds. It has a moderately positive view of emerging market government bonds and global credit.

Longer-term strategic views

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.

Asset allocation team’s five-year allocation view on equities, as of September 30.. From a strategic perspective, the team has a neutral stance on U.S. equities, European equities, Japanese equities and Chinese equities. It has a moderately positive view of global emerging market equities and Canadian equities. The Asset allocation team’s five-year allocation view on fixed-income assets, as of September 30.. From a strategic perspective, the tam has a moderately underweight stance on U.S. government bonds, European government bonds, Japanese government bonds and Canadian government bonds. It has a moderately positive view of Emerging markets government bonds and global credit.

Table showing five-year return forecast for fixed-income assets in U.S. dollar terms, as of September 30, 2020. Expected five-year returns for U.S. investment grade bonds in USD terms is broken down as the following: income return, 1.6%; price return, -1%; expected total return, 0.6%. Expected total return in Canadian dollar terms, -0.9%. Expected five-year returns for Canada investment grade bonds in USD terms is broken as the following: income return, 1.7%; price return, -1.4%; currency return, 1.5% expected total return, 1.8%. Expected total return in Canadian dollar terms, 0.3%. Expected five-year returns for U.S. high-yield in USD terms is broken down as the following: income return, 5.6%; price return, -1.7%; expected total return, 3.9%. Expected total return in Canadian dollar terms, 2.4%. Expected five-year returns for U.S. leveraged loans in USD terms is broken down as the following: income return, 4.5%; price return, -1.1%; expected total return, 3.4%. Expected total return in Canadian dollar terms, 1.9%. Expected five-year returns for U.S. Treasury inflation-protected securities is broken down as the following: income return, -1.2%; price return, 1.4%, expected total return, 0.2%. Expected total return in Canadian dollar terms, -1.2%. Expected five-year returns for emerging-market debt in USD terms is broken down as the following: income return, 4.8%; price return, 0.3%; currency return, -0.1%; expected total return, 5.1%. Expected total return in Canadian dollar terms, 3.6%. Expected five-year returns for Asia investment grade bonds in USD terms is broken as the following: income return, 2.9%; price return, -1.2%; currency return, 0.8%; expected total return, 2.6%. Expected total return in Canadian dollar terms, 1.1%. Expected five-year returns for global government bond in USD terms is broken as the following: income return, 0.5%; price return, -0.8%; currency return, 0.8%; expected total return, 0.5%. Expected total return in Canadian dollar terms, -1%.

Table showing five-year return forecast for developed market equities in U.S. dollar terms, as of September 30, 2020 Expected five-year returns for U.S. large cap is broken down as the following: income return, 1.7%; nominal gdp/growth, 5.7%; valuation, -3.3%; expected total return, 3.9%. Expected total return in Canadian dollar terms, 2.4%. Expected five-year returns for U.S. mid cap is broken down as the following: income return, 1.8%; nominal gdp/growth, 6.2%; valuation, -0.1%; expected total return, 7.9%. Expected total return in Canadian dollar terms, 6.4%. Expected five-year returns for U.S. small cap is broken down as the following: income return, 1.6%; nominal gdp/growth, 5.8%; valuation, -0.6%; expected total return, 6.7%. Expected total return in Canadian dollar terms, 5.2%. Expected five-year returns for Canada large cap in USD terms is broken down as the following: income return, 3.3%; nominal gdp/growth, 3.6%; valuation, -0.6%; currency returns (against the U.S. dollar) is 1.5%. Expected total return is U.S. dollar terms is 7.9%. Expected total return in Canadian dollar terms, 6.4%. Expected five-year returns for Canada small cap in USD terms is broken down as the following: income return, 2.5%; nominal gdp/growth, 4.6%; no change valuation; currency returns (against the U.S. dollar) is 1.5%. Expected total return is U.S. dollar terms is 8.6%. Expected total return in Canadian dollar terms, 7.1%. Expected five-year returns for Europe, Africa and Far East large cap in USD terms is broken down as the following: income return, 2.9%; nominal gdp/growth, 5%; valuation, -0.6%; currency returns (against the U.S. dollar) is 1.3%. Expected total return is U.S. dollar terms is 8.6%. Expected total return in Canadian dollar terms, 7.1%. Expected five-year returns for Europe, Africa and Far East small cap in USD terms is broken down as the following: income return, 2.2%; nominal gdp/growth, 5%; no change in valuation; currency returns (against the U.S. dollar) is 1.4%. Expected total return is U.S. dollar terms is 8.7%. Expected total return in Canadian dollar terms, 7.1%. Expected five-year returns for global large cap is broken down as the following: income return, 2.1%; nominal gdp/growth, 5.4%; valuation, -2.3%; currency returns (against the U.S. dollar) is 0.5%. Total return is U.S. dollar terms is 5.5%. Expected total return in Canadian dollar terms, 4%. Expected five-year returns for Europe equities in USD is broken down as the following: income return, 3%; nominal gdp/growth, 4%; valuation, -2.3%; currency returns (against the U.S. dollar) is 1.4%. Expected total return is U.S. dollar terms is 7.8%. Expected total return in Canadian dollar terms, 6.2%. Expected five-year returns for Japan equities in USD terms is broken down as the following: income return, 2.3%; nominal gdp/growth, 4.7%; valuation, -0.5%; currency returns (against the U.S. dollar) is 0.8%. Expected total return is U.S. dollar terms is 7.3%. Expected total return in Canadian dollar terms, 5.7%.

Table showing five-year return forecast for Asia and emerging-market equities in U.S. dollar terms, as of September 30, 2020 Expected five-year returns for emerging-market equities is broken down as the following: income return, 2.4%; nominal gdp/growth, 6.5%; valuation, -1%. Currency return vs. the USD is 0.1%. Expected total return is U.S. dollar terms is 8%. Expected total return in Canadian dollar terms, 6.5%. Expected five-year returns for emerging Latin America equities is broken down as the following: income return, 3.2%; nominal gdp/growth, 5.6%; valuation, -0.8%; currency returns (against the U.S. dollar) is 2.8%. Expected total return is U.S. dollar terms is 10.6%. Expected total return in Canadian dollar terms, 9.1%. Expected five-year returns for emerging-Europe equities is broken down as the following: income return, 5.4%; nominal gdp/growth, 3.1%; valuation, -0.2%; currency returns (against the U.S. dollar) is 2.8%. Expected total return is U.S. dollar terms is 11.4%. Expected total return in Canadian dollar terms, 9.8%. Expected five-year returns for emerging Asia equities is broken down as the following: income return, 2.0%; nominal gdp/growth, 6.8%; valuation, -1.3%; currency return (against the U.S. dollar) is -0.4%. Expected total return is U.S. dollar terms is 7%. Expected total return in Canadian dollar terms, 5.5%. Expected five-year returns for India equities is broken down as the following: income return, 1.1%; nominal gdp/growth, 8.4%; valuation, -0.8%; currency returns (against the U.S. dollar) is 0.4%. Expected total return is U.S. dollar terms is 9%. Expected total return in Canadian dollar terms, 7.5%. Expected five-year returns for China equities is broken down as the following: income return, 1.7%; nominal gdp/growth, 7.5%; valuation, -2.0%; currency returns (against the U.S. dollar) is -1.8%. Expected total return is U.S. dollar terms is 5%. Expected total return in Canadian dollar terms, 3.5%. Expected five-year returns for Hong Kong equities is broken down as the following: income return, 3.3%; nominal gdp/growth, 4.6%; valuation, 0.8%. Expected total return is U.S. dollar terms is 8.6%. Expected total return in Canadian dollar terms, 7.1%. Expected five-year returns for Taiwan equities is broken down as the following: income return, 3.2%; nominal gdp/growth, 3.9%; valuation, -2.2%; currency returns (against the U.S. dollar) is 0.3%. Expected total return is U.S. dollar terms is 5.2%. Expected total return in Canadian dollar terms, 3.7%. Expected five-year returns for S. Korea equities is broken down as the following: income return, 2%; nominal gdp/growth, 4.8%; valuation, 0.2%; currency returns (against the U.S. dollar) is 1.5%. Expected total return is U.S. dollar terms is 8.6%. Expected total return in Canadian dollar terms, 7.0%. Expected five-year returns for Singapore equities is broken down as the following: income return, 4.8%; nominal gdp/growth, 4.4%; valuation, 1.5%; currency returns (against the U.S. dollar) is 1.1%. Expected total return is U.S. dollar terms is 11.9%. Expected total return in Canadian dollar terms, 10.3%.

U.S. real estate investment trusts: from a 6 to 12-month perspective, moderately negative. U.S. real estate investment trusts continue to be weighted down by the impact of the health crisis in the short term, most notably in the lodging, retail, financing, and office sectors. We expect fundamentals to remain weak over the near-term horizon. U.S. real estate investment trusts: from a five-year perspective, neutral. Real estate investment trusts continue to trade at compelling valuations relative to 12 months ago, and we expect a rebound to occur over the next five years. Yields within this space should be strong—perhaps stronger than many IG bond sectors. However, we do expect the sector’s recovery to be slow and vary by segment, particularly those most heavily affected by the COVID-19 pandemic. While we have long stated that REITs should be an element of a diversified asset allocation, we’re aware that the way we use commercial real estate could evolve post-COVID-19, which could have implications for the asset class. Global natural resources: from a 6 to 12-month perspective, moderately negative. Oil prices plateaued recently following a sharp rebound in the weeks after hitting historic lows in April. We expect prices to be rangebound for the foreseeable future, and we have a slightly negative view on equities tied to this space in the short term. In the precious metals space, we remain positive on gold—its safe haven status should help it shine in what’s likely to be a period of volatility. Global natural resources: from a five-year perspective, neutral. We expect oil prices to slowly grind higher over the five-year horizon, but we remain cognizant that geopolitical events may temper this rise. Significant fiscal and monetary stimulus may lead to an increase in economic activity, but it could also lead to higher levels of inflation in the longer term, which could augur well for this asset class, especially if supply doesn’t increase substantially. Hard assets: from a 6 to 12-month perspective, neutral. We tend not to make significant shifts in this asset class in the short term due to liquidity issues. Hard assets: from a five-year perspective, moderately favorable. We continue to have a favorable view of the asset class. Hard assets such as infrastructure and real as an attractive fixed-income alternative should appeal to investors who can withstand moderate levels of illiquidity. Direct real estate is likely to experience some of the same challenges as REITs over the immediate term, but for now, it continues to deserve a place in the broader portfolio on a strategic basis.

Table showing five-year return forecast for alternatives/real assets in U.S. dollar terms, as of September 30, 2020 Expected five-year returns for U.S. real estate investment trusts is broken down as the following: income return, 3.9%; nominal gdp/growth, 1.7%; valuation, 1%; Expected total return is U.S. dollar terms is 6.6%. Expected total return in Canadian dollar terms, 5.1%. Expected five-year returns for global natural resources is broken down as the following: income return, 2.9%; nominal gdp/growth, 4.7%; valuation, 0.6%; currency returns (against the U.S. dollar) is 0.4%. Expected total return is U.S. dollar terms is 8.6%. Expected total return in Canadian dollar terms, 7.1%. Expected five-year returns for global listed infrastructure is broken down as the following: income return, 3.9%; nominal gdp/growth, 4.4%; valuation, -0.4%; currency returns (against the U.S. dollar) is 0.5%. Expected total return is U.S. dollar terms is 8.4%. Expected total return in Canadian dollar terms, 6.8%.

Table showing five-year return forecast for hard assets in U.S. dollar terms, as of March 31, 2020 Expected five-year returns for global timberland and farmland is between 6%–9%; historical standard deviation is over the period is expected to be 6.6. Expected five-year returns for U.S. commercial real estate is between 6%–8%; historical standard deviation is over the period is expected to be 7.6. Expected five-year returns for Canadian commercial real estate is between 5%–8%; historical standard deviation is over the period is expected to be 3.5. Expected five-year returns for global infrastructure is between 7%–9%.

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.

Important disclosures

A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.

The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.

This material, intended for the exclusive use by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication and are subject to change based on market and other conditions. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.

Neither Manulife Investment Management or its affiliates, nor any of their directors, officers, or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment, or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer, or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against a loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.

Manulife Investment Management

Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams, along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.

These materials have not been reviewed by and are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional.

Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd., which is authorized and regulated by the Financial Conduct Authority; Manulife Investment Management (Ireland) Ltd., which is authorized and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U). Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G). South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC, and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.

Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates, under license.

524618