The NatWest Markets Year Ahead 2020 - a different view from consensus. For us, next year sees the end of monetary policy dominance and so much more...
With our 2020 global markets and strategy outlook just being released, we’ve talked to James (Jim) McCormick, Global Head of Desk Strategy. Here we ask why he and his team are slightly more pessimistic about the US market compared to other market observers, but more positive about Europe. And what the possible return of fiscal policy tools – such as increased government spending or tax cuts – has to do with it.
Q&A with Jim McCormick, Global Head of Desk Strategy
6 minute read.
You say in your 2020 outlook that you’ve come to some different conclusions from consensus about markets globally. Where do you differ?
We disagree with consensus in quite a few places actually. Overall, we’re less concerned for some markets and more for others. Or, to put it in bull’s terms – we’re more bullish for some geographies, meaning we expect stronger growth, and less so for others compared to consensus.
Our key points are: We’re less negative on Europe (especially Italy, where we’re more positive about Italian government bonds) and we’re also a little more positive on emerging markets.
Looking at the US, considering the implications of a tight Presidential election next year, we’re not as optimistic as the consensus. In line with that, we’re more pessimistic about the path of the US/China trade relations, believing there’s a high risk of tariff threats escalating again in the wake of the elections.
For the UK we do agree with the consensus that the economy will have a good start to the year, but we’re more concerned than others about what happens once the negotiations around the new UK/EU trade deal get going.
And finally on markets, we have many differences compared to consensus. I want to mention three, where our outlook is more positive than that of other market observers: We’re more constructive on emerging markets, Italian bonds and inflation markets.
Brexit is on everyone’s mind, and you just mentioned you’re more concerned than the consensus about what’s going to happen. Give us some details, please.
To sum it up: We predict a burst of optimism, which will then however be followed by a return to reality.
Initially, UK markets will rally on a General Election outcome that likely leads to the ratification of the Withdrawal Agreement between the UK and European Union in January 2020. However, the Withdrawal Agreement is merely ‘the end of the beginning’. The UK and EU will quickly shift toward negotiations around the future trading relationship. If, as seems likely, the current Conservative government is negotiating this trade deal, the likelihood is the outcome will be a harder Brexit than what many investors presently believe is likely.
Net-net, this will mean that the Brexit burst for UK markets at the start of the year may have a limited shelf life.
You said you’re making the point in your 2020 outlook that Europe will perform better than many expect. Why are you more positive than others?
First of all, it is fair to say the pessimism around Europe has not been without cause. Brexit uncertainties have manifested into significant economic weakness in the UK with large spill over to the broader region. However, one of our biggest out-of-consensus calls for 2020 is that the wall-of-worry surrounding Europe is too high.
We see political risks easing a little in the UK and Italy. Economic growth will be weak, but not as weak as consensus and markets think. Most importantly, we believe that Germany will finally pull the trigger on fiscal policy and will help, either through public spending – ending austerity – or tax cuts, to set a floor for the region’s weakest link.
You just mentioned fiscal policy. Let’s unpick this. Do you suggest we could see a turn in policy from monetary tools such as interest rates to fiscal instruments such as increased government spending and/or tax cuts?
Indeed, we do. We think the policy mix is changing, away from our reliance on central banks like the Federal Reserve and the European Central Bank and more towards government spending, i.e. fiscal measures, particularly in Europe and especially in Germany.
It’s an interesting time to call that because in 2019 we saw another year where central banks dominated. They eased a lot and as a result of that, every asset class we track was positive on the year. But things are changing: central banks are running out of ammunition; that’s especially true in Europe. More importantly, if you look at the impact of this monetary policy, we’ve see very little by way of inflation and quite a lot by way of asset markets distortion. So the policy mix needs to change. We think it will move away from monetary policy, we think it will move toward fiscal policy, and the impact on financial markets will be quite significant.
And to go back to Germany, which I mentioned earlier, we see the country in the driver seat of that fiscal story in 2020. While investors largely remain sceptical that the German coalition government will pull the trigger on a large stimulus via tax cuts or public spending, we think they will. If we are right, a floor should be set on German growth next year, but the underlying message is even more important: it will signal that the era of the so-called monetary dominance in Europe may finally be coming to an end.
Looking across the ocean, what do you make of the US markets?
Our other big out-of-consensus call is that we expect economic and political risks to shift more clearly towards the US in 2020. Corporate sector confidence has already weakened, likely driven in part by the US/China trade war, and our main concern is that fragile business sentiment will not improve as we head into a closely contested Presidential election – one with different potential outcomes for the business.
You pointed to the emerging markets (EM) potentially performing stronger in 2020 than generally expected. What are your thoughts?
EM lacked a coherent theme in 2019. Underneath the surface, however, I’d say EM performance in 2019 was quite encouraging, considering a backdrop of weak manufacturing, trade war escalation, a rising dollar and more than a few political flare-ups. As we head into 2020, the outlook for EM is improving, at least a little. Broadly speaking, EM growth has improved, helped in part by on-going efforts by China to stabilise its economy, hence we’re more optimistic than others about EM.
Another common question that always comes up when looking to the year ahead is about valuation. Where are the valuation gaps? Where should investors look for opportunities, where should they be cautious?
We see plenty valuation gaps, and there are five key ones. Firstly, in currencies the big story really is that the US dollar is becoming very expensive and secondly, European currencies are very cheap. It’s been the case for a very long time but we think the narrative is changing, with more downside risks for the US dollar in 2020.
Fixed income started quite expensive last year, it got even more expensive this year. That is particularly true in Europe and especially in European credit. Italian bonds are probably the cheapest fixed income product in the region, even with some of the fundamental concerns.
In equities, valuations are mixed. I think the real story there is that the US market is getting more and more expensive both in relative and absolute terms.
And finally for 2020, we still see good value in emerging markets, but perhaps a little bit less in emerging markets local currency denominated bonds because of the stellar performance that we saw in 2019.