Factors closer to global economic fundamentals should win out in 2020, and on balance we are prepared to maintain risk in our views.

This week our Asset Allocation Committee (AAC) releases its quarterly 12-month outlook.

Much of the discussion happened before the end of 2019—and certainly before a U.S. airstrike killed Iranian General Qassem Soleimani on January 3. Is this a classic case of being overtaken by events?

Some commentary described this strike as the most significant thing to happen in the Middle East since the U.S. invasion of Iraq in 2003—more significant than the Arab Spring uprisings, numerous regime changes, an attempted coup in Turkey and the rise and fall of ISIS.

Surely, then, it must have major economic and market repercussions?

Complex and Unpredictable

Maybe. But then again, maybe not. These things work themselves out in complex and unpredictable ways, such that even the geopolitical ramifications are not always clear to experts, let alone their knock-on effects in financial markets. Markets can be efficient at discounting the impact of higher oil prices or lower interest rates, but they struggle to discount a tail event such as an attack on a major city.

Moreover, it is seldom easy to draw the link between geopolitical events and market risk premia. Global equities sailed calmly through the Iraq invasion and its aftermath. Even rising oil prices after 2003 can be attributed to a mess of factors that had nothing to do with tensions in the Middle East. The real story of those years, at least for the economy and markets, was an insidious buildup of global financial imbalances and unsustainable leverage in U.S. housing.

Political Risks Set the Mood

That said, politics and geopolitics were an important part of the AAC’s discussions, even before the events of the New Year. In fact, they were front-and-center when we were considering our “10 for 2020” investment themes back in November.

As the major central banks acknowledge the limits of monetary policy, we think “fiscal dysfunction,” or the current lack of fiscal policy to match the economic environment, will become a bigger driver of markets. Investors will be looking for signs of fiscal loosening, particularly in Europe.

The way that the U.S. election campaign unfolds could be an important determinant of CEO confidence and corporate investment in 2020, and therefore market sentiment and returns. If “Super Tuesday” reveals a Democratic frontrunner, that could set the mood decisively, one way or the other, for the rest of the year.

Most importantly, a Phase One agreement between the U.S. and China and greater certainty around Brexit appear to have mitigated last year’s key risks to global trade. That has already sparked a relief rally.

Fundamental Factors

Together with our starting point in terms of valuations and the business cycle, we think these will be the geopolitical developments that drive returns in 2020, rather than events in the Middle East. Oil, gold and equity futures markets may swing with the morning headlines for a while, as they did last week. Ultimately, however, factors closer to global economic fundamentals should win out, especially now that the world is less reliant on Middle Eastern oil, and energy infrastructure is better protected. Recall how swiftly the market moved on after the drone attack on Saudi facilities last September.

In this week’s AAC Outlook, we put those factors into the balance and come out with marginally greater appetite for risk.

The cycle is clearly extended and valuations are stretched, causing us to stay neutral in our overall view for global equities. But the removal of some important global trade risk enables us to be positive on credit, and to favor value stocks and cyclical sectors over defensive growth. This also translates into more appetite for non-U.S. exposure, particularly in emerging markets.

These opportunities look more intriguing than other parts of the market, and a more attractive way to gear into a macro backdrop that looks brighter to us than it did last year—notwithstanding the events of the past 11 days.

In Case You Missed It

  • Euro Zone Composite PMI:  +0.3 to 50.9 in December
  • ISM Non-Manufacturing Index:  +1.1 to 55.0 in December
  • Euro Zone Consumer Price Index:  +1.3% in December year-over-year
  • China Consumer Price Index:  +4.5% in December year-over-year
  • U.S. Employment Report:   Nonfarm payrolls increased 145,000 and the unemployment rate remained unchanged at 3.5% in December

What to Watch For

  • Tuesday, January 14:
    • U.S. Consumer Price Index
  • Wednesday, January 15:
    • U.S. Producer Price Index
    • China 4Q 2019 GDP
  • Thursday, January 16:
    • U.S. Retail Sales
    • NAHB Housing Market Index
  • Friday, January 17:
    • U.S. Housing Starts and Building Permits

– Andrew White, Investment Strategy Group

Statistics on the Current State of the Market – as of January 10, 2020

Market Index WTD MTD YTD
S&P 500 Index 1.0% 1.1% 1.1%
Russell 1000 Index 1.0% 1.2% 1.2%
Russell 1000 Growth Index 1.9% 2.5% 2.5%
Russell 1000 Value Index 0.1% -0.2% -0.2%
Russell 2000 Index -0.2% -0.6% -0.6%
MSCI World Index 0.6% 0.9% 0.9%
MSCI EAFE Index -0.1% 0.2% 0.2%
MSCI Emerging Markets Index 0.9% 1.7% 1.7%
STOXX Europe 600 -0.2% -0.2% -0.2%
FTSE 100 Index -0.5% 0.6% 0.6%
TOPIX 0.8% 0.8% 0.8%
CSI 300 Index 0.4% 1.6% 1.6%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index 0.0% 0.0% 0.0%
Citigroup 10-Year Treasury Index -0.3% 0.8% 0.8%
Bloomberg Barclays Municipal Bond Index 0.3% 0.7% 0.7%
Bloomberg Barclays US Aggregate Bond Index -0.1% 0.4% 0.4%
Bloomberg Barclays Global Aggregate Index -0.5% -0.1% -0.1%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.3% 0.5% 0.5%
ICE BofAML U.S. High Yield Index 0.3% 0.5% 0.5%
ICE BofAML Global High Yield Index 0.2% 0.4% 0.4%
JP Morgan EMBI Global Diversified Index 0.3% 0.5% 0.5%
JP Morgan GBI-EM Global Diversified Index 0.5% 0.2% 0.2%
U.S. Dollar per British Pounds -0.1% -1.4% -1.4%
U.S. Dollar per Euro -0.5% -1.0% -1.0%
U.S. Dollar per Japanese Yen -1.4% -0.8% -0.8%
Real & Alternative Assets      
Alerian MLP Index 0.4% 2.4% 2.4%
FTSE EPRA/NAREIT North America Index -0.1% -0.7% -0.7%
FTSE EPRA/NAREIT Global Index -0.6% -0.7% -0.7%
Bloomberg Commodity Index -0.8% -0.2% -0.2%
Gold (NYM $/ozt) Continuous Future 0.5% 2.4% 2.4%
Crude Oil WTI (NYM $/bbl) Continuous Future -6.4% -3.3% -3.3%

Source: FactSet, Neuberger Berman.