2020 Outlook
Still positioned for a sideways market
Sébastien Galy, Sr. Macro Strategist, Nordea Asset Management

We expect the economic slowdown to spread till the first half of 2020 before China leads a moderate economic rebound that should slowly extend into 2021. This means that our theme of “Japanification” with a heavy focus on fixed income continues, but there eventually will be rising opportunities in equities preceded by those in emerging markets.

A full cycle of Fed rate cut rather than a mid-cycle correction
The Emerging Markets (EM) slowdown had an outsized impact on US manufacturing fed by stories of a US recession that have been propagated through investment banks and the media. The result is that the confidence of US conference board CEOs is close to an all-time low, with very negative consequences on the economy. This shock is starting to impact consumers, who are spending less than expected at a time when government spending and especially trade is not helping. We expect this contagion to spread and consumer savings to rise as this deleterious story takes hold though a US/China trade deal in Q1 2020 should help to reverse the situation.
The odds are therefore that the Federal Reserve will go for a full cycle of easing rather than a mid-cycle correction. The Fed fund rate currently expects 71 basis points in rate cuts by the end of 2020. The odds are we’ll see a rate cut in December and that by mid-2020, Fed fund rate cuts will have fallen to around 50 basis points. Given that this is a purely temporary shock, we expect a rapid economic rebound and by mid-2021, when the Fed should be on a path of tightening once again. The pace of tightening should be slow under Democrats as we will likely be in a fiscal contraction given pressure from Republicans to rein in spending.

Implications
The impact on the dollar versus emerging markets and EM hard and local currency fixed income should be quite positive for these asset classes. The impact on equities should be mixed to positive for defensive stocks as it reduces their financing costs (e.g. utilities) while the demand shock should initially hurt cyclicals and growth stocks. Such a complex world is one for managed US equities and fixed income. Finally, the dearth of safe havens, including higher yielding US Treasury, should drive the demand for safe-haven assets from Japanese Government Bonds to European Covered Bonds, particularly in Italy and Greece.

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A more constructive outlook on the European periphery
We expect the mix of European growth and inflation to stay very subdued and improve in the second half of 2020, led by a recovery in Germany, Spain, Italy and Greece. Germany should benefit from a fiscal package of likely around 1% of GDP focused again on the transformation of its economy into a “Green Economy”, a process being advanced in Nordic countries. The periphery of Europe should benefit strongly from the past and continued flattening of their sovereign yield curves. Month after month, cheaper lending by banks translates into better economic activity, which translates into lower credit risk for banks, allowing them to lend more. This happened to Spain, which has been averaging above 2% growth since 2015. Furthermore, the eventual rebound in China should help German and Swedish growth. More broadly, an economic rebound combined with an eventual rebound in oil should benefit Nordic economies quite significantly.

Implications
This offers both thematic and tactical opportunities within European equities, particularly those with a defensive tilt like covered bonds and listed infrastructure. On the fixed income side, an eventual improvement in growth and a less dovish European Central Bank should create some shocks in Italian and Greek fixed income, but we expect these to be transient as the longer-term earnings outlook remains subdued giving fixed income a strong bid in a correction. In general, we continue to be very constructive on Italian and Greek credit risk.

An eventual rebound in Emerging Markets
By the second half of 2020, the Chinese economy will have started to rebound, but the recovery should be moderate as it will be hampered by weak bank balance sheets and high leverage (total debt is 280% of GDP year end 2018).- Similarly, the Indian economy should be recovering by then, but moderately due to a combination of bank balance sheet issues and the rapid transformation of old economies. That leaves Emerging Market equities in a somewhat attractive position—but not everywhere. Exposures to German or Swedish stocks are likely good proxies.

Implications
Goods tailored for the new generation that offer a multiplicity of services and experiences, such as Apple and Samsung, should do well. This suggests that US growth stocks which are typically heavily leveraged on Emerging Market economies also should eventually do well. More broadly, we expect Asia Pacific and Latam Equities to eventually rebound amid increased commodity demand. Furthermore, some Emerging Market countries should be supported by the eventual rising demand for energy, such as Indonesia and especially Russia which offers a stellar fixed income market. In Emerging Market Fixed Income, the picture is a complex one suggesting active management. The transformation of old sectors into new ones means that economies like India and Turkey will be less inflationary than they were in past economic rebounds. In countries that lack savings, competition for funds should steepen sovereign curves for bonds of more than two years of maturity. This is the case for countries such as Indonesia and the Philippines, while longer dated bonds in countries rich in savings, such as Russia, are a far better bid.

Conclusion: Japanification and initially mostly sideways equities
We continue to prefer well diversified and resilient portfolios with significant defensive assets such as listed infrastructure and covered bonds, particularly from Italy and Greece. EM fixed income should benefit from Fed easing (though not everywhere) while EM and European equities (e.g. Sweden) should be a good place to position for an eventual rebound in China and then the United States.

Note: This is a NAM macro view, not the official Nordea view.

About Nordea Asset Management
Nordea Asset Management (NAM, AuM 229.1bn EUR*), is part of the Nordea Group, the largest financial services group in the Nordic region (AuM 313.8bn EUR*). NAM offers European and global investors’ exposure to a broad set of investment funds. We serve a wide range of clients and distributors which include banks, asset managers, independent financial advisors and insurance companies.

Nordea Asset Management has a presence in Bonn, Brussels, Copenhagen, Frankfurt, Helsinki, London, Luxembourg, Madrid, Milan, New York, Oslo, Paris, Santiago de Chile, Singapore, Stockholm, Vienna and Zurich. Nordea’s local presence goes hand in hand with the objective of being accessible and offering the best service to clients.

Nordea’s success is based on a sustainable and unique multi-boutique approach that combines the expertise of specialised internal boutiques with exclusive external competences allowing us to deliver alpha in a stable way for the benefit of our clients. NAM solutions cover all asset classes from fixed income and equity to multi asset solutions, and manage local and European as well as US, global and emerging market products.

*Source: Nordea Investment Funds, S.A., 30.09.2019

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