We expect the global economy to remain in a recovery regime.
The global economy continues its gradual healing process. Based on our macro regime framework, we expect the global business cycle to remain in a recovery regime, with growth below trend and expected to improve over the next few months. Recent economic data show that more regions around the world have now entered a recovery regime, with Europe and Emerging Asia still leading the way. While momentum in the US has slowed down, market expectations remain tilted toward an improving growth environment over the next few months.
Figure 1: Leading economic indicators suggest the recovery is broadening, but Emerging Asia and Europe continue to exhibit stronger momentum.
Figure 2: Improving growth expectations, signaled by rising risk appetite, suggest the global business cycle should continue to recover over the next few months.
Meaningful economic policy developments in Europe contributed to higher market sentiment, in our view. The creation of a European Recovery Fund was of utmost importance to avert risks of a prolonged recession in parts of Europe, but also may minimize the threat of a new European debt crisis, the return of Euro break-up risk, and a repeat of the costly impasse of 2010-2012. For the first time in the history of the Euro, authorities have agreed to a large-scale economic program of mutual support in a timely manner, clearly signaling to the market their willingness to find a political compromise and embrace a common path forward during an emergency.
We believe there are two main threats to this favorable cyclical outlook:
- loss of fiscal impulse in the United States, caused by expiring benefits and other policies of social support;
- a second wave of COVID-19 cases in the northern hemisphere during the fall, causing the largest economies in the world to re-instate lockdown measures.
We believe a second round of lockdown measures is likely to have a less severe impact than the first, given a lower level of uncertainty in the marketplace and a higher level of preparedness in the economy compared to the initial shock. However, such a shock would be enough to tilt the economy back into contraction, and it still represents a non-negligible probability. We expect our framework to adjust in a timely manner if the probability of this scenario increases meaningfully.
We maintain a higher risk posture than the benchmark in our Global Tactical Asset Allocation model, sourced through an overweight exposure to equities and credit at the expense of what have been negative or low yielding government bonds outside the US.1 In particular:
- Within equities we hold large tilts in favor of developed markets outside the US and emerging markets, driven by more favorable cyclical conditions, attractive local asset valuations, and an expensive US dollar which, in our opinion, is in the early stages of a long-term depreciation cycle. The confluence of these medium and short-term drivers increases the potential for long-term capital inflows in non-US equity markets. As a result, we hold a large underweight position to US equities, especially in quality and momentum stocks, given our tilts in favor of value and (small) size factors. The underperformance of small and mid-cap value stocks versus large cap quality and momentum stocks continued to be one of the most prominent and surprising features of this market recovery.1 While rational economic explanations for such a divergence can be found in the technology-driven nature of the Covid-19 recovery, as well as the Quantitative Easing-driven interest rate environment, even a modest recovery in the global earnings cycle for small and mid-cap value companies can lead to a positive impact on prices, given high operating leverage and attractive valuations.
- In fixed income, we maintain an overweight exposure to US high yield credit, emerging markets sovereign dollar debt, and event-linked bonds at the expense of investment grade corporate credit and government bonds, particularly in developed markets outside the US, given what has been the negative yield environment.1 Overall, we are overweight credit risk and neutral duration versus the benchmark.
- In currency markets, we maintain an overweight exposure to foreign currencies, positioning for long-term US dollar depreciation. Within developed markets we favor the Euro, the British pound, the Canadian dollar and the Norwegian kroner. In emerging markets, we favor the Indian rupee, Indonesian rupiah and Russian ruble.
1 Source: Bloomberg, L.P., as of 7/31/20
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Credit risk defined as DTS (duration times spread).
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The opinions expressed are those of Alessio de Longis as of August 7, 2020, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions, there can be no assurance that actual results will not differ materially from expectations.
Diversification does not guarantee a profit or eliminate the risk of loss.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The dollar value of foreign investments will be affected by changes in the exchange rates between the dollar and the currencies in which those investments are traded.
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