BBVA Asset Management: "For the first time in recent years, we see more potential in European stock exchanges than in the S&P 500"
The global economy is in the mature phase of the cycle, with an outlook for growth below potential in most countries. However, the rise in stock exchanges in 2020 should be largely due to valuation and, to a lesser extent, profit. "For the first time in recent years we see more potential in the European stock exchanges than in the S&P 500," said Joaquín García Huerga, head of Global Strategy at BBVA Asset Management, during the presentation of "Market Vision 2020."
García Huerga explained that, after ten years of expansion, expectations for 2020 reflect growths below potential in most countries. Likewise, the balance of risks is downward biased, at least until the first phase of the trade agreement between the U.S. and China is signed.
Although, in 2019, fiscal policy has had an expansive bias – similar in global terms to 2018 – current budget plans do not allow for a positive global fiscal momentum in 2020. "It makes sense that the few countries that have room to implement a more expansive fiscal policy, specifically Germany, do so. However, structural reforms that have the capacity to increase the potential growth of economies should not be forgotten," he said.
Mature economic cycle
In the U.S., BBVA Asset Management expects growth to approach 1.5% (below the potential) in 2020. The U.S. economy shows some signs of exhaustion, but the absence of serious macroeconomic imbalances (low household debt levels and a healthy financial sector) and monetary policy support limit the risk of a recessive scenario. "The greatest risk we see for the economy is a strong 'shock' of confidence, not only in the manufacturing sector but also in the services sector, which would probably come hand in hand with a resurgence of the trade war, with a much greater impact than expected on corporate investment and employment plans," he explained.
In the eurozone, GDP in 2020 will grow slightly below its 1% potential, burdened by foreign demand, with limited space to strengthen monetary support and implement an expansionary fiscal policy. Domestic demand will continue to drive growth, supported by a labor market that continues to create jobs. Private sector savings, at historical highs, will slow down slightly, increasing the role of public spending.
As for China, GDP growth may continue to show moderation in 2020 towards rates close to 5.5%, with an estimated negative impact of the recently approved tariffs of about 0.4 percentage points via exports.
In Latin America, the outlook for Mexico for 2020 remains far from its potential, with an expected growth of less than 1.5%, while in Brazil, after the approved reforms (especially the pension reforms), there is an improvement in expectations and domestic activity indicators, thus improving the growth outlook for 2020.
Joaquín García Huerga, head of Global Strategy at BBVA Asset Management.
Somewhat more volatile inflation
Core inflation in the U.S. could remain at rates higher than 2% in 2020, but with a tendency to moderation in the second half of the year. For general inflation, higher volatility can be expected, with an initial downward trend from the expected maximum at the beginning of the year and subsequent convergence towards core inflation.
With the last movement of October, the U.S. Federal Reserve believes that the current approach to monetary policy may continue to be appropriate if the economy progresses in line with its expectations, pointing to at least short-term rate stability. "However, the expected loss of momentum for the economy (with growth rates below potential) can lead, according to our models, to some additional drop in rates in 2020 (in line with what is discounted by the market) although inflation remains above the 2% target," said BBVA Asset Management's strategist.
In 2020, the rise in stock exchanges should occur (again) in large part due to valuation and, to a lesser extent, to profits
In the eurozone, core inflation remained in the 1% range during 2019, and estimates suggest that it will continue to grow at similar rates throughout 2020, supported by the inertia of eurozone salary growth. General inflation would be slightly higher (1.25% on average in 2020). Interest rates should remain at -0.5% and "quantitative easing" will take place throughout 2020. "An additional drop in rates by the ECB is not ruled out, especially now that there is a 'tiering' system that dampens the negative effect of banks, but this is not our baseline scenario," he explained.
Potential of 10% in European stock exchanges
"For the first time in recent years, we see greater potential for rise in European stock exchanges, around 10%, than in the S&P500, at 3%," said Joaquín García Huerga. In 2020, the rise in stock exchanges should occur (again) in large part due to valuation and, to a lesser extent, to profits, because these will only grow between 2% and 5%. Therefore, this is a forecast that rests more on a scenario of containment of political and economic uncertainty than in pure economic growth.
According to BBVA AM, European indexes have greater potential for rise than the S&P500 because, although the dynamics of profit will be similar, they have wider room to normalize their risk premium. The economic cycle's length, the support of central banks and the truce on the trade front are the reasons that lead the fund manager to expect lower risk premiums in the indexes, i.e. they can quote at a higher valuation range in a sustained manner. "In terms of risk-adjusted return, and although we think that stock exchanges will experience an upward trend, we prefer to recommend some caution, due to the maturity of the macro cycle and because the risks are political and therefore unpredictable," he said.
The rise potential of the Ibex, which theoretically can reach 15%, can be corrected, because it depends on a lower risk premium, the interest rates in the eurozone not falling any further, and the macroeconomic situation in Spain continuing to be supported.
BBVA AM has a slight preference for emerging stock exchanges over developed ones, because the growth differential may be in favor of the former by a decimal point or so. However, the big difference may come from the better performance of corporate profit in emerging economies.
Credit is expensive by valuation, but very supported by the search for return in a constructive environment for risk
No much room for growth of sovereign debt
In a context of predictably stable monetary policy or, in any case, with accommodative bias, the profitability of U.S. and German 10-year sovereign bonds would not have much room for increase, remaining at historical lows. The forecasts for one year from now place the U.S. 10 year-bond at 1.8% and the German bond at -0.4%, very close to the current levels. Therefore, the slight steep movement of yield curves would, in any case, derive from decreases in the shortest terms.
As García Huerga explained, credit is expensive by valuation, but very supported by the search for return in a constructive environment for risk, supported by the accommodative policy of central banks. "We expect low returns but, in our central scenario, these returns will be positive again for another year." The U.S. may have a better relative performance than Europe, both in the investment grade segment and in the "high yield" segment, partly because U.S. bonds offer higher coupons.
Preference for emerging fixed-income assets
"Emerging fixed income remains our preferred asset, especially if we analyze expected return against assumed risk," he said. Diversified investment, i.e. incorporating several geographies, it offers a positive differential of 300 basis points for the debt issued in dollars of emerging countries. The key factors that support the asset are moderate economic growth, controlled inflation and, therefore, margin for additional declines in rates in several emerging countries.
Some global weakening of the dollar
The dollar may experience some global weakening from current levels. This loss of strength is based on a scenario of U.S. growth below potential. In addition, the stabilization of global growth favors a lower demand for dollars due to security factors, contributing to this downward movement in the currency. In spite of an outlook for greater global weakness of the dollar, slightly worse forecasts for the eurozone (reflected in the persistence of an ultra-lax monetary policy by the ECB) limit the possibilities of recovery by the euro against the dollar, thus favoring stabilization at around current levels.