Siren call

Review of 2019 and preview of 2020

16 December 2019

5 minute read

What can the past year teach us and what do we need to worry (or not worry) about in the year ahead?

The past year has provided yet more compelling evidence for robust earplugs to be at the top of every investor’s Christmas list. Maybe Santa could helpfully block some websites and TV channels too. Last Christmas, the sirens, as usual singing of imminent economic doom, managed to lure many more unfortunate investors onto the rocks of disinvestment or excessive defence. Stock markets briefly plunged last December as we were again told that the end of the economic cycle was finally here.

However, losses were soon made good. As the world economy proved itself fit to carry on without major catastrophe, stock markets rallied strongly (Figure 1). Those who had believed the (ever) over eager prophets of doom were left on the sidelines ruing their gloom.

FIGURE 1: Stock markets have rallied this year

Figure 1: Stock markets have rallied this year

Source: FactSet, Barclays

Past performance of investments is not a reliable indicator of their future performance

To be fair, even to a committed advocate of the benefits of getting and staying invested, 2019 did not look like an especially appetising year. It certainly did not portend almost every major asset providing strong returns (Figure 2). The world economy has so far not slumped into recession as many feared; however, neither has it generated the kind of growth that would more normally be associated with such equity market returns. Quite the reverse in fact. The world economy has latterly been flirting with stall speed again, amidst a combative political backdrop, slower Chinese growth and a sharp manufacturing inventory cycle.

FIGURE 2: Every major asset class has provided strong returns

Figure 2: Every major asset class has provided strong returns

*ATS as of 25/11/19. Source: Factset, Barclays. Asset classes in USD. For the asset class indices and a table of historical discrete annual performance, please see the table below

Past performance of investments is not a reliable indicator of their future performance

Asset class annual returns 2014-2018

FIGURE 1: Asset class annual returns, 2014-2018

Asset classes in USD and represented by the following indices: Cash & Short Maturity-Bonds, Bloomberg Barclays US Treasury Bills; Developed Government Bonds, Bloomberg Barclays Global Treasury Hgd; Investment Grade Bonds, Bloomberg Barclays Global Agg Corp Hdg; High Yield and Emerging Markets Bonds, ICE BoAML US HY Master II Constrnd (40%), JPM EMBI Global Diversified (30%), JPM GBI-EM Global Diversified (30%) from 1 August 2016, ICE BoAML US HY Master II Constrnd (50%), JPM EMBI Global Diversified (20%), JPM GBI-EM Global Diversified (30%) from 15 January 2018; Developed Markets Equities, MSCI World NR; Emerging Markets Equities, MSCI EM NR; Commodities, Bloomberg Commodity; Real Estate, FTSE EPRA/NAREIT Developed NR; Alternative Trading Strategies (ATS), HFRX Global Hedge Fund. Source: Bloomberg, FactSet, as at 31 December 2018.

Perception vs reality

In our ever more reductive world, much nuance and truth is wilfully marginalised in favour of something more sensational. Truthiness, factoids and fake news are the words of the moment. This missing nuance is important in capital markets where the box office stories remain the Trade War, Brexit, and the next recession. These stories have managed to hoard almost all of the available oxygen and, given their ability to still attract readership, are stretched to help explain more than they should or could.

For example, easily the most alluring explanation of the slowdown in China is the trade heat that this most mercurial of US administrations continues to apply. While there is a kernel of truth to this, it’s an oversimplification.

China’s slowing economy also owes itself to misaligned incentives. In the last few years, Chinese authorities have moved to turn the credit spigots down, both bank and non-bank. The aim was to combat the mushrooming potential for disruptive risks to financial stability. However, the problem was that it was the more efficient, profitable and less leveraged private companies that suffered the bulk of the squeeze. The remaining flows of credit naturally gravitated towards the areas of the economy benefiting from an implicit state guarantee – lumbering state-owned enterprises.

The trade war has certainly played its role in bruising private sector confidence the world over, just as recently cooling tensions may be helping the corporate sector find its feet (Figure 3). However, we remain wary of the caricature of the world economy as Pinocchio to President Trump’s Geppetto.

FIGURE 3: Corporate sector is finding its feet

Figure 3: US Institute for Supply Management

Source: FactSet, Barclays

Neither should we assume, as many seem to, that the Federal Reserve has control of any of the strings. These actors tend to have the ability to influence interest rates and confidence at the margin, but mostly there tend to be grander, less easily simplified forces in motion.

What matters

This year amply demonstrates the need to be ‘on the pitch’, fully invested at all times. We have less ability to see the future and the recessions that lie ahead than widely advertised. Those indicators that are of some use can only feasibly influence how we allocate at the edges of our diversified mix of assets. We have managed to slightly add to portfolio and fund performance again this year through just such tweaks and adjustments.

However, looking into 2020, surely we can say that the risks of a recession are higher still? Not necessarily. 2020 is already looking like a year when the world’s governments decide to make more use of these basement interest rates to borrow and spend a bit more. With business confidence now in the process of stabilising at low levels, a moderate bounce is now in the offing.

More importantly for investors, the act of worrying about the next recession must not be allowed to overcome the instinct to invest for the future. The point about investing remains the ability to both fuel productivity and harvest its rewards. The timing and scale of these rewards has always been uncertain. However, the history of the world economy tells us that they are much more frequent and reliable than the recessions that occasionally punctuate this growth story.

There will be plenty of politics to grapple with again next year. The campaign trail for the 2020 US Presidential elections will create deafening noise for investors. However, there will be very little signal in there.

Untrammelled power will not be conferred on the eventual victor. Trade tensions will likely remain no matter who wins, as will growing angst about the tech titans’ increasingly apparent political and economic muscle. Developed world tax burdens may shift for both consumers and companies. However, for long-term investors this may be less important than many claim. History seems to indicate very little relationship between tax rates and the trend growth rate that is at the nexus of long-term investor returns (Figure 4). Again, we, and everyone else, lack the ability to predict such changes with the confidence necessary to actually make asset allocation decisions ahead of time.

FIGURE 4: Little relationship between tax and growth rates

Figure 4: US tax rates and the trend growth rate

Source: US Federal Reserve Economic Data, Barclays

So we should look to the new year with the usual mix of cautious optimism and humility that a study of the past gives us. Growth remains the norm. The political backdrop is certainly disconcerting in some parts at the moment, but remains less influential than feared.

Certainly, parts of the world’s capital markets are expensive, perhaps dangerously so in some instances. Investors have been guilty of overpaying for safety and protection in a jittery economic cycle, in the long shadow cast by the Great Financial Crisis. However, we don’t think stocks are prohibitively priced still, even if the profits outlook is a little meagre. A diversified, multi-asset class fund or portfolio predictably remains the best weapon to bring to bear on all of this uncertainty and opportunity… that and some earplugs.

Things to consider

The value of investments can fall as well as rise. You may get back less than what you originally invested.

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