Bond investors have a reputation for being a slightly gloomy lot and, given all the apparent challenges and tensions in the global economy, it would be easy to side with the doomsayers. But setting aside anaemic growth in UK GDP, and concerns about Germany entering a “technical” recession, I’m going to break ranks and say that I believe the fundamentals are now in place for a global economic recovery.
The saying that “history does not repeat itself, but it rhymes” is often (possibly) misattributed to Mark Twain. Whether or not the great wit himself ever uttered or wrote these words, the aphorism has a certain ring of truth when it comes to the prospects for global markets, which have seen an extraordinary sequence of troughs and peaks, with each recovery coming about as the result of the ultimate removal of some form or other of economic “blockage.”
The history bit…
Even for those of us who were active participants in the bond markets at the time, it is sometimes easy to forget that a mere decade ago, driven by collapsing property price bubbles and resultant commercial bank failures, Europe was in the throes of a sovereign debt crisis so serious that global leaders began to worry that it would threaten the very viability of the euro. Equities and other risk assets fell sharply, and Greece’s sovereign rating was cut to “junk” status, while Italy, Spain and Portugal narrowly avoided a similar fate.
The policy response to the unfolding crisis was gargantuan; vast interventions by the European Central Bank, the International Monetary Fund and the then newly-established European Financial Stability Facility effectively guaranteed “peripheral” European sovereign debt to the tune of hundreds of billions of euros, in return for the imposition of swingeing austerity measures.
While painful, the response – best characterised by former ECB president Mario Draghi’s infamous “whatever it takes” comment – played a significant role in averting a European economic cataclysm. With fears of economic collapse abating, investor risk appetite made a tangible comeback. The healing process may be ongoing, but it is noteworthy that in October of this year, Greece was able to issue €1.5 billion in 10-year sovereign bonds at a yield of just 1.5%. It’s a similar picture in Italy, Spain and Portugal, too.
By the first days of 2016, investors were faced by a new set of concerns, as uncertainty over the strength of China’s economy sent risk assets globally tumbling once more. Again, it was the policy response of the authorities – this time in China – that helped to “unblock” investor sentiment, as they put in place a range of stimulus measures designed to set the economy on a more stable footing, albeit with economic growth expected to be slower than in previous years. Once again, resumptions in economic growth and risk appetite followed.
Fast forward several more years, and the next economic “dampener” emerges on the horizon in the form of rising geopolitical tensions, characterised most notably by a tariff-based trade war between the US and China. Amid rising investor concerns over the effect of the trade war on global growth, the US dollar strengthened markedly on the back of its perceived safe-haven status and attractive interest rate differential over other major currencies, adding to geopolitical malaise, and creating a new “blockage” to global economic growth.
At the time of writing though, there are encouraging signs that Sino-US trade tensions are easing; this, accompanied by accommodative monetary policy from the US Federal Reserve (Fed) – itself allowing the US dollar to give up some of its previous resilience – should prove just the tonic the global economy needs as we head into 2020. Against this backdrop, it becomes markedly less difficult to see corporate investment improving in the months ahead, and for consumer confidence to remain robust.
The global economic downturns and resurgences that have characterised the last decade have each had their own nuances, but a pattern nevertheless emerges.
While a supportive Fed, a softening US dollar and an easing in global trade tensions should be cause for celebration for investors, I should emphasise that risks remain: the US has already spent significantly on fiscal stimulus; Chinese measures have, thus far, been tentative at best; and Europe has been, in my view, too slow off the mark to stimulate its economy. Support for global growth, and therefore for risk assets, is nevertheless there, for those willing to see it.
Such developments have already led to strong returns from emerging market debt in 2019, and I expect to see the asset class – now firmly “in from the cold” – to see further inflows in 2020. Elsewhere, credit spreads look reasonably attractive, supported by expectations for renewed corporate resilience.
As the most recent economic blockages dissipate, I believe the market has been excessively bearish on inflation pricing, so expect to see some attractive opportunities there, too. The corollary of this, of course, is that developed market sovereign bond yields may well rise; in this environment, we’ll be watching our duration exposure – already marginally negative in absolute return portfolios – with care.
Do I believe that risk assets will be off to the races in 2020? No. But forced to choose between forecasting a global recession and a reasonable improvement in economic growth, for this particular bond investor, it would have to be the second choice.