2020 has not been an easy year to manage so far, with COVID accelerating our longer term thinking − that many economies would have little choice but to continue to cut rates and provide continued monetary support to maintain the status quo. The best case scenario for global growth in 2020 ahead of COVID was tepid growth, a far cry from the reflationist and high growth narrative that was popular in some market circles into late 2019. The combined US Federal Reserve (US Fed) hiking cycle of 2016 to 2018 was still feeding through into economic activity with a drag (traditional monetary policy operates with a 12-18 month delay) and it was likely the economy would struggle to foster higher growth as a result.
Data now shows that the US likely entered recession in February 2020, but that will never matter, it will always be that COVID killed the expansion and collapsed the economy as we know it. With much debate about what the economy may look like going forward, certainly in the near term until either a vaccine or herd immunity is reached, we know the economy will be highly constrained, operating as a shadow of its former self. A 2008 economy at 96% of 2007 was enough to crush credit markets and send off a death spiral of loan delinquency. This is far, far worse. In the US Fed’s Chairman Powell’s own words, ‘’the path forward is extraordinarily uncertain.’’
In this short video we share our views on the current environment, as well as outlining 4 possible predictions to end the year.
Hi, I'm Charlie Jamieson, Chief Investment Officer at Jamieson Coote Bonds, and this is a review of markets in June 2020. Well, what an extraordinary year 2020 is already turning out to be. As we reached the halfway point, the full COVID-induced episodes that we've all had to live through, and its just fostered so much change in such rapid acceleration of many themes in life, in politics, in the social fabric of the way that society is put together, and absolutely, in markets and policy evolution as well.
Some of that change has clearly been positive if you're lucky enough to be able to work from home. We've leapt forward in the use and uptake of technology like Zoom and FaceTime and Teams and all of these other operating meeting platforms, but clearly so much of it has been negative. It's been destructive for economies, for livelihoods, and for many folks, it's been outright, deadly and horrifying.
So it's an amazing time to reflect on that first half a year and what we might face as we approach the second half of the year. Clearly, in a year where really anything seems possible now, we put some predictions together. We don't believe with high probability that any of these can occur, but we just threw some up which we thought could be interesting. Clearly a lot of them are around the U.S. Presidential election, right through from if Trump loses, does he not acknowledge the election result and barricade himself inside the White House with some loyal generals? All the way through to maybe he doesn't even run. Maybe his polling numbers are so bad and he's so arrogant, he won't put himself forward to lose. Markets are more focused on Biden at the moment and his accelerated lead over Trump. Should the Democrats take the Senate and the House then clearly there can be some rollback of those generous tax changes, which the market's enjoyed in 2018/19. We can see change in valuations around the technology space and some banking spaces and the like.
We could get a vaccine, hopefully, we do in 2020, and that would be a great positive surprise. That's very difficult to estimate with any degree of certainty, but we hear a lot about vaccine development and huge amounts of motivation to deliver that.
The European recovery fund and European unity could be another good positive surprise. At the moment there's a group of nations called the Frugal Four, which are against common debt issuance in the Eurozone. They are the Scandis, Holland, and Austria, but should there be some development there, and certainly this is primarily driven by Germany, and they've come a long way in wanting to move to this kind of framework, I think European markets would love that, and then other global markets can lead on from that.
On the negative for the predictions, of course, there's got to be more geopolitics that we worry about. Certainly, with Trump at the helm, we know that it's a very chaotic world in terms of geopolitical negotiation and what his policies might be. He does flip flop around a lot. Hopefully, we might get to a life soon enough without Trump and get a little bit more certainty in some of those outlooks because clearly it's a very murky outlook on the geopolitical front right now.
As we're at the halfway point in the year, it's a good time to review our secular framework and our thinking around the way the economy was going to perform this year.
Now best case scenario before a COVID world was that we would have very mild growth in the global environment.
That was as a result of the rate-hiking cycles that the Federal Reserve had embarked upon through 2016, '17, '18. That was still having an effect in terms of cooling economic outputs. I think what we'll see now in the revised data is that the U.S. was slowing very materially before COVID. Now no one will ever remember that, it will always be the COVID slow down, so it doesn't really matter whether we got that right or wrong because everything as I said has been so accelerated by this virus and the policy responses that have been thrown into markets to try and stem what is clearly a huge cashflow gap that has been created.
We still believe that we'll be in these policy settings for a long time. We know that interest rates will not be rising anywhere in the world for a long time. It's much more likely in the near term that we will have a much more powerful disinflationary, if not deflationary force before we can then talk about some mild uptick in inflation later on. We still believe that the disinflationary forces are very powerful leading into this being demographics, technology, robotics, automation, very high debt burdens, and of course, these things are constantly seeing inflation outcomes much lower than we've had previously.
Chairman Powell of the Federal Reserve made the comment,
"That we've had 128 months of sub-inflationary outcomes versus their own policy objectives before this time."
He made comments only last week that,
"The pathway forward is tremendously uncertain."
We still feel that this is going to be the more likely way that the markets will behave and those inflation outcomes will be very muted before we might think about the de-globalisation actually lifting inflation a little bit, but that's probably a longer-term thing for us to bring into our portfolios.
As we look back on the first six months of the year, bonds have had a tremendous outperformance versus many asset classes showcasing why they are such an important portfolio allocation. There's always naysayers about the bond market, but we've seen fantastic performance, good, strong negative correlation for most of this period.
We do make the classic George Soros commentary.
"I'm not predicting this, I'm observing it."
Certainly what we are observing from many other jurisdictions as rates have become low or even negative in many parts of the world, is that this portfolio role still plays a really important role for not only volatility suppression, but in terms of outright performance, with bond markets like Japan and Germany generating very strong total returns despite being at zero or negative interest rates.
Luckily in Australia, we're nowhere near those kinds of outcomes. But as we have explained previously in our global funds, we can use the FX hedging market to increase the yield on some of those assets. We still feel that these offerings have a tremendous role to play and can still generate a very good total return in what is a very low returning world. We have very low interest rates all around the world and bonds are still going to apply that great defend and protect type role for portfolios, and clearly with high-grade bonds offer fantastic liquidity to give investors portfolio optionality.
Thank you very much.
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Charlie, I enjoy your updates and articles, for me, they are clear and balanced. I would appreciate an article from you or a link to something that already exists that describes how good returns are generated with bonds in this low-interest environment. You made the comment again in this update that it has good returns have been generated in low or negative interest rate countries in Europe and Japan. I can't get my head around this and do not have bonds in my portfolio because of it. I understand the defensive safe return and low-risk capital retention side of it in an environment where interest rates and equity returns are falling, but in my head, if rates rise, then the value of my bonds would go down and I would receive a low return. There is some very basic understanding I don't see to grasp. Maybe the skill is in the trading?