Q How are you looking towards 2020?
We are at the point of maximum uncertainty. We are still feeling the after effects of policy tightening last year. We clearly have a huge amount of uncertainty, which is impacting investment and spending decisions, linked to issues ranging from the trade war between the US and China to the Hong-Kong riots and Brexit. But some of these issues are showing some slightly more positive signs at the margin and, clearly, policy has been eased significantly.
The question now is: will the consumer and services and the labour market hold up long enough for policy easing and the other more positive dynamics to play out, or are they essentially already cracking under the weight of weak manufacturing, weak trade and, weak investment? Are we actually already sliding into recession?
Q So, it’s between weak manufacturing signals or robust consumer and labour sector signals?
It has been an interesting cycle. I think, ultimately, the labour market is linked to business, because if businesses are struggling, they don’t hire, they fire. It is the same with wages. The labour market is bending, weakening but not yet breaking. If it can continue to hold up, then I think those more positive dynamics can play out, but it is on the edge. Many of the indicators that we look at which tend to anticipate changes in the unemployment rate, more than half of those are looking quite weak and quite threatening, but not yet decisively so and one or two of them are still looking pretty robust.
We are on the edge. We, hopefully and probably, will avoid sliding into recession but I think it is at the point of maximum uncertainty now. It will be a few months at least before we have greater clarity although, clearly, the equity market is hopeful and maybe the bond market is telling us the reverse; it is fearful.
Q What are the risks and opportunities you see in 2020?
If we get the all clear, I think the big opportunity is for some rotation. It is an unusual cycle in that normally with most cycles recently the US economy has led and it has been Europe and Asia that have followed to some extent. This time around, because the epicentre of the slowdown has been in manufacturing and trade, which is essentially what Europe and Asia are good at, if we get an inflection point there, it’s those economies, those industries that are going to do well.
So if we avoid recession and have a soft landing and recovery, you have got an opportunity for repricing of more cyclical assets, non-US assets, to some extent probably financials as well because the other thing that is likely to happen in those circumstances is people will begin to review price expectations and monetary policy. This means bond yields will essentially rise, yield curves might steepen a bit simply because the bond market at the moment is trying to weigh up the odds of whether the US Federal Reserve will just carry on cutting eventually to zero, because the economy is so weak or becomes weaker, or whether its actions have actually been a stitch in time. The Fed has cut three times, which is a typical mid-cycle or late cycle insurance cut or set of cuts. It may not need to do more if the economy soft-lands and ultimately recovers.
Q So how do you prepare for such binary outcomes in 2020?
You want to play those two outcomes differently.
One way you can hedge your bets is you can own options. Options give you a skewed pay-off. They allow you to participate in one direction but not the other, so to the upside and not to the downside. There is a cost involved in that but now that cost is not expensive. Given the level of uncertainty, the pricing of options, particularly in things like the equity market, looks cheap to us.
I think you need to be properly diversified and make sure that you are not running an excessively high level of risk, but rather you are running a lower level of risk than normal. I think then you need to look for those opportunities in markets that are already pricing in a lot of bad news, so (as I said) some of the more cyclical parts of the market, opportunities in equities outside the US, potentially in financials and probably the opportunities we think are more in equities than in other growth-related assets, like credit. Even if the cycle extends, it is still too late in the cycle I think to get excited by things like high yield.
The other thing that is beginning to happen is a slight turn in the dollar. So the exceptionalism of the US, where the US has outperformed on a serial basis and the Fed has been one of the few central banks able to tighten policy, is changing. The US is now weakening relative to the rest of the world, particularly if we get a soft landing. Also, the Fed is now easing policy potentially more aggressively than other central banks are because they have less scope to. So, I think we are not looking for significant dollar weakness, but the sort of persistent dollar strength which has been a problem for the rest of the world, I think, is showing signs of fading.
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