Each quarter, we use our asset model to provide capital market assumptions. Below is a brief synopsis of the report commentary. A download of the full report can also be found here.
During the final months of 2019, further monetary easing by the US Federal Reserve (the Fed) and de-escalating tensions in the US-China trade war boosted investor confidence. This led to a rally in global equity markets that ended the year on a high note.
Global Growth predictions for 2020 suggest a slowdown from 2019's modest pace. The rise in bond yields comes from the very low base, following the yield curve inversion panic during the summer months. This suggests central banks are likely to cut interest rates further and are taken as a signal of an impending recession. Signals from the Federal Reserve (the Fed) that its cutting phase was ending seem to have broken that cycle and triggered the rebound in October. Three months of respite later, bond markets are more relaxed but the Fed's next move is once more expected to be downwards, and the UK and Japan are expected to beat them to it. Remarkably, the most likely to raise is the European Central Bank (ECB). The economic slowdown was felt by investors across the globe, but UK investors can be forgiven for not noticing, due to the ongoing noise around Brexit.
Investors switching back from bonds into equities as the anticipated recession failed to materialize helped equities rally to end the year on a high. The same rotation pushed bonds down and yields up, but it was still a great year for bonds: rates are still near all-time lows and central banks are expected to cut rates sooner rather than later. In these conditions, strong equity performance is a puzzle. One current explanation is that investors expect central banks to loosen monetary policy, effectively squeezing the herd further out of cash and bonds and into equities. But that means that the recent strength of equity markets is resting expectations of weak economic performance.
The UK market shared in the rise but the combination of the election of a government with a robust majority and the reaffirmation of its commitment to what would have been called a hard Brexit means there is more to unpick. The pound rose strongly when the election was announced and the FTSE outperformed. However, apart from a brief spike on the day of the election result, the pound hasn't moved much. The Bank of England is expected to cut rates sooner rather than later and the overseas income that kept UK shares looking healthy when it was weak cut the other way now. The UK property market sends similarly mixed signals as apparently strong rental markets and a rate environment that continues to be supportive have not been enough to prevent some property funds feeling the need to suspend trading and more experiencing outflows at rates that mean they can't be far from doing the same.
Rising yields across markets herald a similarly broad rise in expected returns from the model. This is mostly a rising tide and the most notable exception is in UK equity returns. There the market appears to have got ahead of the fundamentals. An imminent rate cut may be supporting prices that are not reflecting the possibility of significant disruption to trading conditions in the short term.