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Thursday 12 December 2019
Investment Talks, Perspectives
In 2019, the 10-year Treasury traded in a range of 1.46%- 2.78%, the fourth widest range since 2010. The 10-year yield rallied due to uncertainty over US-China trade negotiations and ongoing concerns about a weakening global economy. Fueling the rally further was a dramatic pivot in the Federal Reserve’s monetary stance from hawkish to dovish, which led to three rate cuts, and finally to neutral. This backdrop was a catalyst behind a strong 10% increase in the US 10-year yield in 2019. Historically, Treasury performance often suffers following a 10% return the preceding year, as the chart shows.
As we look ahead to 2020, there are enough uncertainties in the geopolitical and global economic environment to result in heightened volatility in the 10-year yield. We highlight a few scenarios that could affect the 10-year in 2020.
On the other hand, a credible and final resolution to the US-China trade war and other tariff threats could remove the single biggest anchor to business sentiment and investment. The Fed could respond to an ensuing surge in economic activity and inflationary pressures by tightening monetary policy with incrementally higher short term rates, potentially pushing 10-year yields above 2.50% .
While the short-term economic outlook certainly impacts bond yields, longer-term expectations for growth and especially inflation are the most meaningful drivers, accounting for the bulk of 10-year Treasury beta, at 0.25 and 0.45, respectively. (Beta is a risk measure related to market volatility, with 1 being equal to market volatility and less than 1 being less volatile than the market.)
The current and longer-term inflationary picture remains benign and well contained. Except for a brief period in 2018, Personal Consumption Expenditure (PCE), the Fed’s preferred measure of inflation, has remained below the Fed’s 2% target since 2014, while the survey measure has been on a noticeable downward trend since 2013, falling from an average of 2.9% in 2013 to tying a record low of 2.3% in November 2019.
The relative flatness of the yield curve suggests expectations for subdued US growth in the medium- to long-term. While there is a risk of higher yields in the US in 2020, the extent of the rise is potentially capped by the combination of trend-like growth and lack of meaningful inflationary pressures.
US growth continues be driven by the consumer, who remains confident due to a healthy income statement and balance sheet. Holiday retail sales are strong, especially for internet sales; however, retailers who lack online strategies are suffering. Manufacturing continues to be weak in the face of uncertainty surrounding a US-China trade agreement.
A macro environment marked by stabilizing growth, loose financial conditions, and an accommodative Fed should be positive for risk assets in general. While we see greater potential for spread tightening in securitized credit than in corporate bonds, we expect both sectors to generate an important carry advantage over Treasuries, which we expect to nudge slightly higher.
U.S. corporations have elevated levels of leverage, which are affordable with low interest rates and spreads at multi-year tight levels. Watch for stress in the event of higher rates.
High yield is attractive on an idiosyncratic basis, especially given technical conditions in the lower quality bank loan segment.
Structured securities, including both agency and non-agency residential mortgage-backed securities (RMBS), are relatively attractive, especially as housing market affordability and valuations have been buoyed by low mortgage rates and steady demand.
Most leading economic indicators suggest that the global cycle has already bottomed, and we would expect the recovery to consolidate if we have a trade agreement. Earnings forecasts should start to improve in the second half of next year, and 2020 is likely to be better than 2019 in term of earnings per share growth: we expect +7%-8% in the US. Valuations are historically reasonable given low rates.
With this as a backdrop, we favor value stocks over growth stocks given the greater exposure within the value universe to cyclical sectors, which would benefit from a re-acceleration of economic growth.
The financial sector is particularly attractive in our view, as it should benefit from a steepening of the yield curve if GDP growth improves, but has limited downside given that consumer debt levels are reasonable and are not likely to result in massive credit losses should a recession occur.
The biggest risk to the equity markets near-term continues to be trade. A continuation of the US-China trade war could cause global economic growth to slow further and earnings to decline next year. The Fed, however, has supported growth with three interest rate cuts this year, and is likely to provide additional support if growth slows further. Because of the sector composition of the market and the flexibility of its corporations, we think the US remains the safest way to invest in equities. Non-US equities could have greater upside, however, if a trade deal is reached and global growth reaccelerates.
The US election cycle may also contribute to equity volatility in the coming year if candidates that are less pro-business were to gain traction.
Overall, we believe equities are attractive for 2020. We also believe that integrating ESG to traditional economic analysis will improve the potential for active management to deliver solid risk-adjusted returns. In fact, as investors move from risk aversion to a more positive outlook, security selection and active management will be critical to navigating the equity investment landscape in 2020.
Unless otherwise stated, all information contained in this document is from Amundi Pioneer Asset Management (“Amundi Pioneer”) and is as of December 12, 2019.
The views expressed regarding market and economic trends are those of the authors and not necessarily Amundi Pioneer, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading on behalf of any Amundi Pioneer product. There is no guarantee that market forecasts discussed will be realized or that these trends will continue. These views are subject to change at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected. Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could result in the loss of all capital invested.
This material does not constitute an offer to buy or a solicitation to sell any units of any investment fund or any service.
Date of first use: December 12, 2019
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