Are recession fears justified?

Financial markets are currently dominated by fears of recession and the ongoing US-China trade quarrels, as well as by geopolitical tensions and general uncertainty. As a result, stock markets are sliding and bond yields are racing to the bottom. What should investors do in such a market environment? And is the situation really as bad as presented in the news flow? Our Chief Investment Officer and Head of Research assess the situation. The audio file of their conversation can be found in the ‘downloads’ section below.

Fears of a recession are rising. Are we heading towards a global downturn?

Christian Gattiker, Head of Julius Baer Research
  • The global economy is currently in a manufacturing recession but not in a broad-based recession.
  • However, the yield curve inversion is a cause of concern.

Yield curves have inverted. What does it mean?

Yves Bonzon, CIO and Head of Investment Management at Julius Baer
  • In the past, the yield curve inverted with some lead time, ahead of US recessions. It mostly did so as a result of the US Federal Reserve (Fed) overtightening at the short-end of the curve. Today, the Fed has actually delivered a rate cut.
  • The long-end of the US yield curve represents the global interest rate: with yields falling in Japan and Europe, and central banks signalling more stimulus, investors take advantage of the higher US yield. Yields thus must come down on the long-end.

What are policy perspectives in light of these developments?

Christian Gattiker

  • Central banks entered the crisis mode in summer with a broad-based rhetoric.
  • So far, nine rate cuts have already been implemented by central banks across the globe.
  • The problem is that investors no longer believe in central-bank rate cuts, which passes the ball on to fiscal stimulus.

Yves Bonzon

  • We see tentative signs of an emerging debate on fiscal policy. This should be particularly relevant in Germany, where the AFD party is gaining popularity and polling first in two German states.
  • But, the rigidity of the system and the continued reliance on the Stability and Growth Pact and outdated economic ideas continue to be a drag on the economy. With the private sector saving, the government not spending the surplus and exports dropping, GDP contraction is the mechanical consequence.
  • A large-scale, Marshall Plan-like fiscal stimulus is necessary to extract the area out of its balance sheet recession and continued ‘Japanification’. 

Trade war fears continue to weigh on markets. What should investors expect and how should they position themselves?

Christian Gattiker

  • The trade war conflict will be played out harshly.
  • In essence, the trade war is not about trade deficits and jobs moved from the US to China. Those aspects are only put forward for the US 2020 election campaign. The real conflict goes way deeper; it is about technological supremacy in the future.
  • We believe this conflict will remain a major topic for longer and will keep popping up possibly over the next ten years.

Yves Bonzon

  • The US president’s tweets in early May and at the beginning of August have prompted us to switch to the ‘external shock’ regime of the Julius Baer Asset Allocation Approach.
  • While we would normally take advantage of such market corrections by harvesting the resulting elevated risk premium (i.e., buying equities), these shocks and the associated market environment are extremely hard to navigate and dangerous to trade, given their uncertain and longer-term impact on the global economy.
  • This is why it is very important for investors to have a robust strategic asset allocation on which they can rely and to which they can stick in these troubled and murky waters.
  • In our own portfolios, we are slightly short-duration, but the bond market has gotten ahead of itself, exhibiting record bullish sentiment. We would rather expect long rates to rise slightly in coming months.

The sentiment is extremely depressed on equity markets. How come, and is it justified?

Christian Gattiker

  • Equity markets are 3%–5% shy of all-time highs and yet clients are asking us about black swan events.
  • This is about investors being as well informed as never before and therefore immediately taking note of any negative news.
  • New all-time highs in some stock markets have created some vertigo with investors.
  • All-in-all, investor sentiment is depressed; this is supportive for risky assets and we expect this situation to continue.

Yves Bonzon

  • Endogenous factors, such as positioning and fundamentals, still look supportive.
  • Risks do exist, for example in the Middle East with tensions rising between Iran, the US and the rest of the local players, but we do not see a reason to panic yet. Risk is well-priced and credit markets are behaving.

What to make of the growing pile of negative-yielding global debt?

Yves Bonzon

  • First of all, one must remember that negative-yielding bonds are only negative yielding at maturity. Positive coupon bonds have a continuous instantaneous positive yield. So investors buying those bonds are engaging in a speculative activity, expecting to sell them at a higher price.
  • Just 12 months ago, we were on the other end of the spectrum. Ten-year US Treasury yields were at 3.2%. Since then they have halved. From here, we should see rates go up rather than down.
  • However, a sustainable rise in yields will not materialise unless there is an important, structured and sustained fiscal push in developed economies.

What sectors or regions should investors favour in this environment?

Christian Gattiker

  • The bull market cycle in equities will continue, with no change in leadership: innovation, information technology, communication – single names in these areas – but also areas like healthcare, will continue to lead.
  • In contrast, there is a fair chance of a junk rally in bombed-out cyclicals such as banks or industrials if there is sufficient policy response.
  • Geographical regions do not really matter at this stage of the business cycle; regional allocation is most interesting when there is asymmetrical monetary policy, such as in Japan or in Europe a few years back. For now, sector allocation and single stock picking prevail.

China is the country investors can no longer ignore. How should investors tackle it from an asset allocation perspective?

Yves Bonzon

  • The two main engines of growth in the modern globalised world, emerging markets and information technology, are converging in China. It is the only economy in the world that provides such exposure to both themes.
  • Actually, excluding China and India, emerging economies are growing at a rate comparable to that of developed countries.
  • It is a global superpower that cannot be ignored and is an essential component of a diversified portfolio. In our strategic asset allocation, Chinese equities are a core asset class, accounting for a full 100% of our allocation to emerging equities.

From a thematic and long-term Next Generation point of view, which areas look most attractive today?

Christian Gattiker

  • The two themes ‘information technology’ and ‘rising Asian consumer’ are both impacted by the ongoing trade war between the US and China. We believe these themes will continue to be important going forward and thus remain attractive for investors.
  • Conservative investors should focus on healthcare and urbanisation within the ‘Shifting Lifestyles’ theme, and digitalisation within the ‘Digital Disruption’ theme.

Conclusion
In conclusion, we stick to the scenario of modest but positive global growth in the near future. While there is potential for more stimulus, monetary policy has lost a great part of its efficiency, and hopefully we will see a greater fiscal push, especially in Europe. The trade war, meanwhile, as we have noted in our previous communications, only extends this bull cycle, as it prompts central banks to ease policy, taking a more cautious stance.

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> Contact us to gain further market insights. The audio file of this CIO and Research Call can be found in the ‘downloads’ section below.

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