NN IP: Asset allocation will remain challenging in 2020

December 5, 2019

• The challenges of 2019 will continue in 2020; high uncertainty limits our conviction levels
• We keep equities as a small overweight, with a preference for non-US equities and a value bias
• Treasuries and Bunds are neutral

Anyone who said at the beginning of this year that the equity and real estate markets would be up 25-30% with negative bond yields would not have been taken seriously. Rising trade risks, continued Brexit uncertainty, social unrest, a slowing economy and an absence of earnings growth were some of the hurdles the market faced in 2019. This probably makes this year’s bull market one of the least-loved ever; few investors fully participated in it. Even for our own tactical asset allocation calls, the political and macro uncertainties translated into only limited active tactical bets.

Markets have climbed the wall of worry, and over the past weeks, the narrative has started to shift. There has been no further escalation in the trade war and the US and China are expected to sign a mini-deal soon. The risk of a no-deal Brexit has declined considerably, at least until January, and there are signs that the manufacturing industry is stabilizing. The once-dominant search-for-yield theme is gradually being replaced by a pro-growth trade, although this is not reflected in the direction of global bond yields, which after an initial bounce in September are trading in a low, narrow range. This reflects easy monetary policy, which is not going to disappear in the foreseeable future.

In November, we retained our allocation in risky assets. Equities are a small overweight; all other asset classes in our model portfolio are neutral. We downgraded US Treasuries from a small overweight to neutral. The political, macro and corporate challenges are likely to remain present in 2020 and sentiment will probably continue to jump back and forth between hope and despair, depending on the daily trade headlines. This is not an environment that promotes aggressive positioning.

Fixed income

We have a neutral stance in German Bunds and US Treasuries. Both the Fed and the ECB will stay on hold for an extended period. Inflation expectations remain too low. Despite the stabilization in the manufacturing outlook, Bund yields did not materially rise and are stuck in a trading range around -30 bps. More clarity on trade and Brexit, or some confirmation that fiscal easing is around the corner, will be needed before we can expect a sustained rise in bond yields.

We are also neutral in fixed income spreads. Within spreads we have a preference for investment grade, in EUR as well as in USD. Earnings support is better among investment grade companies than non-investment grade companies. Moreover, supply is limited and the ECB resumed buying in November.

Equities

In the equity sectors, we introduced a small value tilt by moving utilities to a small underweight and upgrading financials to a small overweight. At the same time, we upgraded materials from a small underweight to neutral. The rationale for this trade is the hope that the stabilization in the manufacturing data continues and that earnings estimates will find a bottom in the second quarter of 2020. This may lead to somewhat higher safe bond yields, a steeper yield curve and a shift from the over-owned and expensive growth sectors (outside technology) towards value sectors.

 Regionally, we maintain our preference for non-US stocks over US equities. This stance is motivated by the reduction of political tail risks, the call for more fiscal policy, an uptick in long-term bond yields and signs of stabilization in manufacturing data. These elements have favourably influenced investor risk appetite. We have small overweights in the Eurozone and Japan keep the US as a small underweight.

Real estate

Global real estate is neutral. Our signal set for the asset class deteriorated in November, moving from firmly positive into negative territory. The weakening was broad-based but most pronounced in market dynamics. Relevant fundamental macro indicators that deteriorated related to global retail sales, unemployment and M&A. US housing market data nevertheless improved. The deterioration in market dynamics concentrated on short-term momentum with rising yields since September. Investor confidence and US consumer confidence were also weaker.

Institutional investor positioning in global real estate had been consensus overweight but is declining sharply, particularly in the US. European real estate positioning remains strong overweight. Investor flows could level off further in response to the Fed’s less dovish stance and as yields rise moderately on improved manufacturing sentiment in the near term.

Also, credit standards for corporates at Eurozone and US banks are tightening, while the perceived risk of a hard Brexit has diminished. Overall valuation of real estate appears fair, albeit with regional differences. US real estate is expensive whereas Eurozone and particularly UK real estate is cheap. The trends toward online retailing and flex work continue to pose structural headwinds.

Commodities

We are neutrally positioned in commodities. The medium-term outlook for commodity demand is bleak, due to continuing tensions between the US and China, slowing global and Chinese economic growth, and fallout from damage already done to the commodity-dependent manufacturing and industrial sector. In the near term, however, signs of bottoming in global manufacturing, hopes of a partial trade deal and an unabated loose monetary policy environment should improve sentiment.

Our quantitative signal set for the asset class deteriorated in November, exclusively due to macro fundamentals. Chinese loan growth was disappointing and oil inventories remained high. The refinery maintenance season extended well into November in the run-up to IMO 2020, the International Maritime Organization’s new rules to reduce emissions from vessels on international waters. Market dynamics, however, improved on better sentiment indicators in social and news media. Momentum indicators also improved following price increases in October.

In the near term, we prefer cyclical commodities, where supply is constrained in segements such as copper. Precious metals may face headwinds from a modest rise in real yields if global manufacturing data improve.