Investment Strategy: Looking in both directions

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As markets hit new highs, the combination of overbought conditions, the possibility of a correction and a lukewarm growth outlook call for caution. ABN AMRO is retaining its neutral stance to stocks, and bonds remain out of favour.

Markets have been running ahead of fundamentals for months. While there has been an upturn in some macroeconomic indicators, we are far from a rosy scenario for stock investing. The market, we believe, is being driven by momentum. Investors are turning toward stocks given very low or negative savings rates, low returns in bond markets and some more positive headlines related to global manufacturing and trade. There are really very few alternatives to stocks for investors seeking returns. Risks are still limited, as there are no signs of recession, but it is still a late-cycle environment.

We do not believe that it is time for investors to make changes to their stock portfolios. Here are our reasons:

  • While no recession is underway, economic growth is expected to remain low, with only a modest pickup in the second half of the year.
  • Earnings growth is under pressure. We believe consensus estimates for forward earnings are too optimistic.
  • As markets continue to hit new highs, the risk of a correction increases.
  • ‘Phase-one’ of the US/China trade dispute has been agreed, but there remain uncertainties regarding the final details. Donald Trump could also now direct his trade focus to other markets.
  • World equity markets are trading closer to their long-term averages, but valuations are significantly above long-term averages.

Given these considerations, the ABN AMRO Investment Committee decided to continue to take a neutral stance toward stocks, while bonds (underweight) remain out of favour.

Equities: US remains in the lead

US equity markets continue to outperform other regions. This is due to the relatively strong economic growth and earnings outlook in the US compared with Europe and emerging markets. We therefore continue to prefer the US (small overweight).

In Europe (small underweight), there are supportive signs for stock investors, including a stabilisation of economic momentum and rising interest rates. Nonetheless, as markets are still driven by the momentum factor and by inflows into technology stocks, the US remains our preferred market. We did, however, increase exposure to European stocks in the last quarter of 2019. To more aggressively invest in Europe compared with the US, we would look for a market that has returned to a valuation orientation.

We take a neutral stance toward emerging markets. Valuations are attractive, but earnings and economic momentum are weak.

Long-term trends support sector preferences

Within equity sectors, we continue to favour the health care (overweight) and information technology (overweight) sectors. Information technology is supported by the digitalisation of the economy, while health care companies benefit from the growth of the ageing population. These are long-term trends that are here to stay.

The consumer staples and utilities sectors remain out of favour (both underweight). These sectors have high valuations and are sensitive to changes in interest rates. We have a neutral view regarding the remaining sectors: communications services, consumer discretionary, energy, financials, industrials, materials and real estate.

Bond portfolios facing challenges

Investment-grade European (nonfinancial) corporate bonds have become a default anchor for bond portfolios. This is largely due to low or negative bond yields in core eurozone countries. There is also reason for some pessimism regarding the government bonds of countries in the periphery of the eurozone. Political risk in Italy, for example, is back. While bonds with more potential return, such as high-yield bonds, can offer more opportunities, some deterioration is seen in the high-yield market. We believe that there is more scope for returns in emerging markets. This is despite the noise around Argentinian debt, where a contracting economy and very high unemployment could complicate debt renegotiations. These complications, we believe, are already priced-in.

Conclusion

The year has gotten off to a flying start, with rising stock markets in a low interest rate environment and few signs of inflation. An initial trade deal between the US and China was agreed in December, which buoyed markets. Uncertainty around the agreement remains, however, and tariffs have not wholly disappeared. In this environment, businesses could continue to curtail capital spending.

And while it is certainly good news that the weakness in industry is bottoming out, the potential remains that the services sector could still be negatively affected. This spillover could have repercussions for the US and eurozone labour markets.

All in all, the outlook for 2020 is more muted than bright. Economic growth in both the US and Europe is expected to slow compared with 2019. The first half of the year is likely to be lacklustre, with only a relatively modest improvement in the second half. There is also uncertainty in the US given the Trump presidency, his impeachment and the 2020 campaign. While central banks around the world are expected to remain supportive, fiscal stimulus remains largely absent. China’s easing has been nowhere near as powerful as in the past, and its monetary policy remains conservative.

It is also increasingly likely that after such a strong run-up in stock markets that a correction can occur. Indeed, the longer the market rallies, the stronger the chance becomes. We therefore believe that a cautious approach is called for. A positive shift in the earnings outlook, a significant economic surprise or a correction would be triggers to reconsider our neutral stance to equity markets.

Richard de Groot
Chair, ABN AMRO Investment Committee

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