2019 has had several unexpected twists and turns, not the least of which has been the return of monetary stimulus. This caused bond yields to fall and equities to rally, as few would’ve predicted 12 months ago. 2020 will no doubt present many new, unforeseen challenges, but that shouldn’t stop us from looking at the data to help inform us about what the future might bring.
I recently reached out to six contributors with a knack for spotting a great chart and asked them for their top chart for 2020. Responses come from Callum Thomas, Topdown Charts; Shane Oliver, AMP Capital; Damien Klassen, Nucleus Wealth; Anthony Doyle, Fidelity; Richard Quin, Bentham Asset Management; and Greg Stock, Perpetual Investments.
Monetary policy stimulus to drive a global economic rebound
Callum Thomas, Topdown Charts
This is one of my favourite charts right now, and is one of my top innovations/new charts of 2019. It shows the net number of central banks whose last move was a rate cut. Interestingly this seems to line up fairly well with the global manufacturing PMI (as you might expect) and leads it by about 8 months, and the punchline is that the global monetary policy pivot we saw this year should drive a rebound in the global economy heading into 2020. At a high level this will be bullish for growth assets, and bearish for defensive assets.
Leading indicator points to an upturn in global growth
Shane Oliver, AMP Capital
2019 was characterised by a slowdown in global growth that led to a recession obsession. But share markets managed to wrong foot many and rise anyway because they were cheap and monetary easing provided the prospect of stronger growth ahead.
But to sustain the rally in shares we now need to see an upturn in global growth. The best guide to whether this is happening is the global manufacturing conditions PMI as seen in the chart. The upturn evident in recent months needs to continue and the easing in global monetary conditions suggests that it will. If not its back to cash and bonds!
Can housing save the economy again?
Damien Klassen, Nucleus Wealth
Australia has: (a) the world's second-most indebted consumers, (b) anaemic wage growth (c) falling credit (d) a crash in housing construction. The government's economic plan seems to be to grow housing credit by:
- Not spending so that the RBA needs to cut interest rates further and
- Letting first home buyers borrow up to 95%.
I'm very doubtful it will work. This chart will tell me if I am wrong.
Equity investors should turn their eye to bonds
Anthony Doyle, Fidelity International
The most important chart for 2020 for equity investors comes courtesy of the bond market. Australia’s 5-year breakeven rate - the difference between the yield of a nominal Australian government bond and an Australian inflation-linked government bond of the same maturity (in this case, 5 years) - has been rising since hitting an historic low in August of only 1.02%. Today, the 5-year breakeven rate stands at 1.30%, suggesting that RBA interest rate cuts are having some impact on investor expectations of inflation. Whilst still 0.70% below the lower range of the RBA’s inflation target, the RBA Board should be encouraged that the decline in inflation expectations has been addressed to some extent.
The reason this chart is key to the market outlook for 2020 is that inflation expectations have a large bearing on the RBA’s thought around monetary policy. If the RBA can see that monetary policy is having a positive effect on a range of economic indicators - such as inflation expectations, the unemployment rate, and economic growth - it will likely be less inclined to cut interest rates in 2020. This would be good news, as it suggests that the earnings outlook for Australian companies would also be improving. Equally importantly, it is unlikely that the RBA will be removing monetary stimulus by hiking interest rates any time soon.
Currently, the market is pricing in another interest rate cut by May 2020, and most economists and analysts have a cautious view on the economic outlook, expecting weak profit growth, further interest rate cuts and possible quantitative easing. I am more optimistic, and expect that the interest rate cuts we saw in 2020 will work by supporting the housing market and consumer spending in time. Should this scenario eventuate in conjunction with a global economic recovery, the outlook for Australian equities may be brighter than many currently expect.
The chart to watch for fixed income investors
Richard Quin, Bentham Asset Management
The most important chart for any credit/fixed income investor is current yields. Investors need to ask themselves - where are you getting your income going forwards?
On current yields, allocations to cash and fixed income are going backwards in real terms. We think floating rate credit can be a very useful asset class which can provide a real yield above inflation, while offering defensive characteristics which are suited to a slow-growth environment.
Chart: Yields for Cash, Fixed Income & Credit Sectors
Fixed income investors should be wary of late cycle risks
Greg Stock, Perpetual Investments
In short, duration continues to rise whilst the compensation for risk continues to fall. The above chart shows how the Commonwealth Government 10-year Bond yield has fallen from over 10% in December 1994 to 1.22% today. Yet the modified duration or maturity of all the bonds in the fixed rate bond index has lengthened from a low about 3.25 year to currently over 5.5 years maturity today. This phenomenon is logical as bond issuers seeing the lower yields on offer, rollover their debt maturities for a longer period than the previous maturity for cheaper funding. Now that bonds are at or near the most expensive yields they have ever been, it is now more than ever time to focus on managing interest rate and credit risk in your fixed income portfolio.
Investors should be conscious of the inherent late cycle risks reflected in both benchmarks/indices but also importantly in terms of products that are being marketed to investors in this climate of low yields. Put simply, some of the higher yielding products promise high returns but investors need to remain conscious of the risk taken to achieve these targeted returns. The role of fixed income is predictability and with that in mind, in today’s environment when thinking about your debt investments, it’s arguably best to keep it short and keep it high quality.
Despite the very different tone in markets from this time last year, there's one thing that hasn't changed - a mixed outlook, largely defined by the direction and effectiveness of monetary policy. In fact that's one thing that all these charts and outlooks have in common is their strong relationship to monetary policy. It's easy to see why Charlie Jamieson from Jamieson Coote Bonds calls interest rates "the virus that affects all asset classes".
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