Dovish central banks to shape late 2019 markets

As the Federal Reserve joins the European Central Bank (ECB) and Bank of Japan in rolling out new stimulus measures, global central banks are making their marks on the investment outlook for the remainder of 2019.

The universe of negative-yielding sovereign bonds has grown to approximately US$13 trillion, according to Bloomberg.¹ However, this phenomenon is not limited to government debt. Bloomberg also reported that nearly a quarter of investment grade credit is now negative-yielding as well.¹

I expect slower growth globally, especially given that I don’t see an end to the trade wars. At the same time, I expect greater volatility, the result of rising geopolitical risks.

However, I believe significant central bank accommodation should not only keep the U.S. and other major economies from going into recession, but should cause, in general, risk assets globally to outperform non-risk assets.

We also must recognize the continued need to find diversified sources of income in this persistently low-rate environment.

The following is my second-half outlook for each region, developed with my colleagues in Invesco’s Global Market Strategy Office:

Canada

We expect the economy to decelerate but only modestly in the back half of this year, as a global slowdown, exacerbated by trade tensions, weighs on the Canadian economy. The labour market remains solid and we believe the Bank of Canada stands ready to act if conditions deteriorate significantly enough, which should help to counter the headwinds facing the economy.

U.S.

We expect the economy to decelerate very modestly in the back half of this year, supported by Fed accommodation, which should benefit U.S. equities. Although business sentiment has weakened, negatively impacting business investment, the consumer remains very strong, helped by robust labour market conditions.

Eurozone

We expect a continued, modest deceleration in the eurozone economy in the next few months although we expect further accommodation from the ECB. In this low-rate environment, we believe exposure to eurozone investment grade and high yield credit makes sense. In addition, eurozone real estate looks most attractive, in our view, given its yield generation and diversification qualities.

U.K.

We are also cautious on U.K. equities in the near term, given so much uncertainty and the increasing likelihood of a “no deal” Brexit. In addition, the Bank of England does not appear ready to provide more accommodation.

Japan

We expect modest improvement for the economy. With valuations attractive for Japanese equities, and the Bank of Japan looking for ways to provide more accommodation, we are slightly positive on Japanese equities.

Emerging markets

In this environment, we are positive on emerging markets. In general, emerging markets (EM) economies are likely to benefit from more Fed accommodation, especially the end of balance sheet normalization. However, we recognize some emerging economies could be negatively impacted if the trade war worsens and the economic slowdown accelerates. Therefore, we are positive on EM equities, but we believe investors need to be selective as some EM markets may not fare well given growing geopolitical risks. In terms of China, we expect its economy to maintain growth at the 6% – 6.5% level. That’s because we believe the government has been effective in providing stimulus to its economy. We recognize that Chinese monetary growth has been lackluster despite this level of stimulus. However, looking at metrics such as loan growth and rail freight suggests growth is solid. In addition, we are also seeing more flows into Chinese equities because of greater inclusion in some MSCI indexes.

Conclusion

In this environment, we believe the bias is towards risk asset outperformance. However, we recognize the dangers that trade wars pose, especially to a global economy that is already slowing.

This is an environment that necessitates both broad diversification at the asset class level and selectivity at the security level. Given that rates will be lower for longer, we believe investors should consider a greater allocation to a variety of fixed income sub-asset classes, including some further out on the risk spectrum, including investment grade credit, municipals and other higher-yield fixed income asset classes, as well as dividend-paying stocks.

We are following recession indicators closely, recognizing the potential need to make tactical shifts in portfolios with shorter-term time horizons if compelling signs of a recession appear. Looking ahead, we will be vigilant in terms of watching for signs that the slowdown turns into a recession. However, at this juncture, we expect the economic expansion to continue – albeit more slowly.