The global economy is fragile

Looking ahead to 2020, the one thing investors cannot ignore is just how fragile the world economy actually is. While we are not forecasting an imminent global recession, our ongoing analysis suggests a rising probability of the inevitable.

Consider the notable challenges currently in train – with little sign of resolution:

• A fatigued consumer complex that is experiencing the fading of one-off US tax cuts.
• An extended US/China trade war that has crimped confidence and capital investment − global macro data worsening is likely.
• South-east Asian export nations – the world’s ‘factory’ that takes in nations like South Korea, Taiwan, Indonesia, Singapore – continue to materially deteriorate.
• Some ten plus years on from the global financial crisis, financial markets are still discussing Quantitative Easing (QE).
• An Australian economy that is highly linked to Chinese fortunes, a story structurally under sufferance. The RBA may apply QE. Should the RBA follow much of the developed world into a program of QE, the currency impacts will likely be profoundly negative.

Adjust the mindset

Investors need to adjust their mindset in this late-cycle environment for 2020 and beyond – what got you ‘here’ previously won’t necessarily get you ‘there’ moving forward.

A greater emphasis on defence in a lower-return environment (alongside with higher volatility) will provide much-needed balance against a wide dispersion of possibilities ahead. In this ‘defensive’ conversation, high-grade sovereign bonds may provide liquidity, stable income and capital preservation against market volatility.

In this late-cycle stage, high-quality assets such as AAA-rated sovereign bonds can play a role in mitigating risk by diversifying portfolios. Additionally, the returns over time and compounding income (see figure 1) mean high grade bonds, whilst offsetting higher risk exposures have performed well for investors.

Figure 1: AAA-rated countries’ 10-year yields and calendar year total returns in local currency. 

Source: JCB team analysis using data from Bloomberg.