Why was our “Solving for 2019” audience less worried about recession but more cautious on equities?
At our flagship annual conference for the EMEA region, “Solving for 2019,” it is now tradition for my colleague Joe Amato to ask the delegates when they think the next recession will hit, and for me to ask which will be the best-performing investment category over the coming 12 months.
Last week, in London, our clients and partners in attendance gave us an intriguing response.
In aggregate, our audience thought that a recession was further off than they did at this time last year. At the same time, they were considerably less bullish on equities and commodities than at the start of 2018. How do we square these positions?
Perhaps it had something to do with the audience’s view that inflation posed the greatest risk to markets in 2018, and that the cycle might end with an equity and commodity blow-out? Or maybe this year’s delegates were feeling bruised from the almost universal negative returns of 2018, and the equity market sell-off that brought it to a close?
At first, it was a puzzle. On reflection, however, the two votes probably reflected a growing recognition that we are in the mature stage of the business cycle—and that this is the most complex and challenging stage for managing an investment portfolio.
Last January, fully 26% of our audience anticipated a global recession in 2018. This year, only 8% expected a recession to hit in 2019.
Despite their gloomy economic outlook, 68% of last year’s delegates backed global equities to perform best in 2018 and another 25% went for commodities. Only 6% got it right by anticipating that cash would be king. Even fewer favored the fourth category of global fixed income.
This year, the picture was much more mixed. Global equities still emerged as the most favored asset class, but this time by just 49% of the audience. Seventeen percent selected global fixed income, 20% commodities and 13% cash.
In aggregate, it was clear that there was less certainty in the room compared with last year. The wisdom of the crowd was providing an important reminder for multi-asset class investors: Now may be a particularly important time to seek diversification and maintain a balance of risks.
Caution, Humility and Balance
Our delegates’ economic outlook appears to have moved closer to our own. We anticipate a “soft landing” for the U.S. and some signs of recovery from the rest of the world this year, which can sustain the current cycle well into 2020 and possibly beyond. But we acknowledge that we are likely much closer to the end of this cycle than its beginning: While last year’s sell-off has made us look a little more favorably on many risk markets, like our audience we also maintain a measure of caution, humility and balance.
After all, positioning for early- or mid-cycle has tended to be relatively straightforward: Keep risk on. It has been equally straightforward at the end of a cycle: Keep risk off. But navigating a mature cycle that still has life in it is more complex.
Equities have the potential for substantial returns, but the uncertainty, and therefore the volatility, is heightened: As the range of potential outcomes for earnings over the next 12 – 18 months gets wider, current valuation multiples become a much less reliable guide to those returns.
While the spread-widening we experienced in December creates short-term opportunity, in general credit tends to be the first place where market exuberance makes it difficult to find value without taking excessive risk. As the cycle matures, it therefore demands greater consideration of the full opportunity set, at all points on the curve, at every layer of the capital structure and in every region.