The year is 2020, and so is hindsight.
In the summer, the recession probabilities in our economic roadmap increased amid an escalation in the trade war between the US and China. This made us more cautious on risk assets.
Well, the situation has improved since then. The global economy appears to have reached a ‘Goldilocks’ equilibrium, with reasonable growth, limited inflation, and central banks committed to defending against slowdowns.
The economic deceleration in China seems manageable now too, and there are even signs of some stabilisation and improvement in Chinese growth numbers.
Our economists have therefore gradually revised their recession probabilities down from their more bearish views.
Markets seem to reflect this bullish sentiment as well. Investors are buying the narrative that President Trump will not want to rock the boat too much with elections approaching and will want to see the S&P 500 rising to bolster his prospects.
At the same time, investor positioning – which we use as a contrarian indicator – doesn’t appear stretched despite such a strong rally, with little movement over the year-end.
The doom of consensus
That is the good news. We are nevertheless still late in the economic cycle, although it is fair to say that the late-cycle dynamics have not worsened over the past few quarters.
We also believe that optimism around the ‘Phase One’ trade deal is generally excessive, given that the agreement covers only a relatively small proportion of US imports (0.1% of GDP) and the president is unpredictable. Amid fresh conflict in the Middle East and in the run up to the presidential election in November, which will follow the Trump impeachment proceedings, the pathway for largest economy in the world is likely to be peppered with hazards.
Developments in China, meanwhile, belie a broader negative trend that includes capital controls and controls on technology exports. China’s relationship with its neighbours, and particularly Hong Kong, also remains fractious.
Yet, on balance, we believe that – with the tailwinds of economic growth, low inflation, and accommodative central banks – there is no immediate catalyst for a correction.
We have therefore upgraded our view on equities from negative to neutral. Our mantra remains it is better to prepare for the future rather than trying to predict it. By remaining cautious regarding crowding in asset classes, we aim to sidestep the traps created by investors herding into the latest trend.
Given our cautious bias we would look to reinstall our underweight position in equities again when we get closer to the US elections, when sentiment becomes overly complacent, or when we see late-cycle pressures like inflation popping up more clearly.
You can read our full Q1 Outlook here, which also features Hetal Mehta on what comes next for the UK after three years of parliamentary gridlock and Martin Dietz on finding opportunities between the traditional asset-class extremes.