Thematic Report

Navigator – Groundhog on a tightrope

by Adrian Mowat / Oct 23, 2019

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The uncomfortable balancing act of recession versus low rates is set to intensify into 2020. Assuming a shallow recession forecast, low rates will ultimately support US equities. The good news is this results in a rangebound S&P500. The bad news is emerging-market underperformance is likely to continue. MSCI EM remains technically weak, however there are a few improving trends, including semiconductors, ecommerce and selected autos including the EV supply chain. A broadening in EM is possible as the headwind of dollar strength moderates and EM growth stabilises.

Efficacy of lower rates debatable
The majority of the world’s central banks are easing policy, but the efficacy of lower rates and QE on the real economy is debatable. Their effects on financial assets, particularly in the USA, has proven supportive. US equities valuations’ versus bonds remain compelling and other valuation measures are not in the danger zone. Developed market easing does allow most emerging-market central banks to reduce rates. This is helpful, but does not differentiate EM from DM.

Are we too glib on the risk of a recession?
Global manufacturing has slowed. September’s US manufacturing ISM of 47.3 is at a post-GFC low. The US yield curve did invert. Our economics team’s base case is a shallow recession in the middle of 2020 with a full-year forecast of 1% GDP growth. Our view is that this will not generate a sustained significant sell-off, as equities remain the Hobson’s choice in a world where safe-asset returns are ultralow. The economic outlook for 2020 and 2021 is similar to the slow-growth world post-GFC, hence the “groundhog day” reference.

Tough year for EM, particularly in Asia
The slowdown arrived early in Asia for semiconductors and autos. Markets and economies suffered from: the Sino-US trade war, a sharp decline in auto sales, a strong dollar, weak renminbi, falling commodity prices, the Hong Kong protests, Japan-Korea disputes, (another) Argentine crisis, Indian capital market taxes and the endless Brexit saga. In much of Asia, GDP growth slowed this year and analysts revised their profit forecasts lower. The delta in 2020 is unlikely to be quite as negative and will be helped by policy support. Indian and Indonesian government re-elections with stronger mandates offer the prospect of more reform.

Our report has asset allocation for two mandates: emerging markets and Asia Pacific ex-Japan
We build the asset allocation from views on the key country sectors in each mandate. China consumer discretionary and communication services are more than 15% of each benchmark, this is larger than EM/Asia Pacific ex-Japan’s second-largest market, Korea. When there is uncorrelated monetary and/or fiscal policy or major events, recommendations will be country driven. Our Underweight on Hong Kong fits this dynamic as protests impact the economy and may alter business models.

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