The 2020 Asset Allocation Outlook

The article below is from our BRIEFINGS newsletter of 07 January 2020

A modest pickup in global growth is expected to greet investors in 2020. While this optimism has seen investors shift to riskier assets, Goldman Sachs Research’s Christian Mueller-Glissmann says there’s a risk that they could be disappointed…eventually. We sat down with Christian to discuss multi-asset themes and risks for 2020.

Christian, how are investors positioned for the new year?

Christian Mueller-Glissmann: Global growth worries, in part due to US/China trade tensions, pushed investors to take more defensive positions in the first half of 2019. Boosted by easier monetary policy, they limited their growth exposure and focused on the search for yield. Growth concerns have started to subside and a moderately more optimistic outlook has supported a rotation towards riskier assets, encouraging investors to increase their pro-cyclical exposure. But markets have moved quickly to reprice for an expected rise in global growth since the summer. As a result, the markets may have overshot—we’ve only seen a moderate pick-up in global Purchasing Manager Indices so far. In the near term, increasing policy uncertainty and growth-related risks could lead to disappointment.

What are your asset allocation preferences for 2020? 

CMG: Most assets performed well in 2019, producing positive returns across the board. While we don’t expect 2020 to be as strong a year for multi-asset portfolios, we anticipate positive returns for equities due to the modest pick-up in growth and elevated equity risk premiums. We also expect global bond yields to pick up. So, we’re modestly pro-risk in our asset allocation recommendations, with an overweight in equities and underweight in bonds. However, on a 12-month horizon we’re moderating our pro-cyclical asset allocation with an overweight in cash because return potential across assets is more limited following such a strong year. Also, we prefer equities to credit because credit spreads are already very tight, creating a poor risk/reward.

What’s your view on stock market valuation? 

CMG: While the macro backdrop should be broadly favourable for equities in 2020, buoyed by loose financial conditions and a resilient US consumer, we believe a large portion of the growth momentum is already priced. The strong 2019 equity performance was driven by valuation expansion, as profit growth has generally remained subdued. If this is met with limited earnings growth, we’ll only see moderate returns in 2020. But late cycle there is always the potential that valuations overshoot as well.

The correlation between equities and bonds has been a central theme of 2019. How will this relationship play out in 2020? 

CMG: With our base case expectation of gradual increases in bond yields, from low levels and mostly driven by breakeven inflation, we think that equity/bond correlations should remain negative. However, after the large increase in 10-year yields so far, a continued bond selloff could drive indigestion for equities. On the flipside, with lower bond yields and less potential for further monetary policy easing, bonds might provide less of a buffer during equity corrections.

What are the key risks as we enter 2020?

CMG: Ongoing political events and policy uncertainty are key considerations. While the impact of the US/China trade tensions should be less negative in 2020 with recent progress on a deal, eventual disappointments cannot be ruled out and weaker China data could reduce risk appetite.

There are also downside risks to earnings expectations due to margin pressures. This risk is most prominent in the US, where there are potential headwinds from global trade tariffs, rising input costs and wage growth, as well as potential US tech regulation, which has been a focus into next year's US presidential election. And of course further tensions in the Middle East and sharp increases in oil prices might weigh on risk appetite.