Foresight | April 2019: key macro themes and market outlook

The last six months have been marked by volatility. Is this trend likely to continue in the foreseeable future? Our asset allocation team shares their short-term and structural views.

We ended 2018 by narrowly escaping a technical bear market in the United States; this year, however, has already produced a double-digit return in most global equity indexes.¹ Central banks have provided much support for both the bond and stock markets—the People’s Bank of China engaged in sizable easing, and most developed-market central banks, including the U.S. Federal Reserve, adopted a dovish tone. That said, investors shouldn’t forget that we’re much closer to the end of the global growth cycle than the beginning, and recession risks will likely remain elevated over the next two to three years.

It’s through this framework that we formulate our return forecasts for the various asset classes over the next five years. Our forecasts are derived from a wide number of sources, including those from the team of macroeconomic strategists that’s embedded within the asset allocation team. While our long-term forecasts lean heavily on model-based valuation estimates, we firmly believe that macroeconomic views play an important role in identifying more short-term investment opportunities in actively managed portfolios.

Chart of five-year asset class forecasts, expected returns, as of March 31, 2019. In U.S. dollar terms, 5-year expected total returns for U.S. large cap is 4.3%, 6.8%  for U.S. mid caap, 6.3% for U.S. small cap, 7.8% for Canadian large cap, 9.5% for Canadian small cap, 7.3% for Europe, Australasia and Far East large cap, 7.6% for Europe, Australasia and Far East small cap, 8.9% for emerging market equity, 5% for U.S. real estate investment trusts, 7.9% for global natural resources, 2.4% for U.S. investment-grade bonds, 4.9% for U.S. high-yield bonds, 6.3% for U.S. bank loans, 5.4%  for emerging-market debt, and 1.6% for global bonds.

Key macro views

Short-term macroeconomic themes

  • Developed-market (DM) central banks, led by the U.S. Federal Reserve (Fed), are likely to have finished hiking interest rates in this cycle. In our view, the next change in interest rate is more likely to be a rate cut than a rate hike. This should keep bond yields relatively well contained globally.
  • U.S. growth dynamics are likely to improve in the second and third quarters of 2019 following a difficult first quarter. We continue to view the U.S. consumer as a bright spot, not just within the U.S. economy, but globally. We believe the expected short-term improvement in U.S. growth, along with some mild reflationary pressures beginning in the summer, should provide support for U.S. equities and nudge U.S. yields slightly higher.
  • China has engaged in substantial fiscal and monetary stimulus that will, in our view, arrest the deterioration in economic data witnessed throughout 2018. This has lifted investor sentiment toward emerging markets (EM), and should continue to offer a tailwind to Asia in general. However, we don’t believe that the Chinese economy will experience a V-shaped recovery unless the authorities engage in additional stimulus, particularly measures aimed at the property and credit markets.
  • After a very difficult 2018, we believe European growth will find a bottom in the second half of this year, supported by more stable growth in China; Europe is also poised to benefit from improved global trade and industrial production activity in the latter part of this year.
  • Geopolitical risks (Brexit, U.S.-China trade relations) will continue to weigh on sentiment.
Table indicating the asset allocation team’s views of different asset classes in the next 6 to 12 months, as of April 9, 2019. The team has a moderately positive view of U.S. and European equities. It has a neutral view of emerging-market equities and Canadian equities. It has a moderately negative view of Japanese equities. In terms of fixed-income assets, the team has a moderately negative view of U.S. fixed income, European fixed income, Japanese fixed income and Canadian fixed income. However, it has a moderately positive view of emerging-market debt.

Longer-term strategic views

  • Based on traditional leading economic indicators, 2020 looks set to be a more difficult year for the U.S. economy, with a small tail risk of recession. However, we expect any weakness to be short-lived and mild relative to past comparisons, with growth resuming toward trend in the latter part of our five-year forecast period. Strategically, this means we favor a modest growth bias in which we can contain risk and take selective opportunities.

  • We believe the U.S. dollar (USD) is likely to enter a structurally weaker period in the coming five years, largely on the back of growing trade and fiscal deficits. This could provide modest tailwinds to most non-U.S. assets, particularly EM assets, and support global growth through easier financial conditions and reduced financial tightening.

  • Despite expectations for a mild increase in price levels in the near term, we see little scope for elevated inflation over the coming five years. We expect DM inflation profiles to remain close to or below 2%. This should keep central banks relatively dovish compared with the past several decades, although we do see most policy rates rising in the latter part of our forecast period as central banks continue to pursue some degree of normalization.

  • We expect economic growth in China to continue to decelerate on a structural basis as the economy transitions away from manufacturing and toward services. That said, we believe EM debt and equities will remain attractive, thanks to valuation and carry.

Table indicating the asset allocation team’s views of different asset classes from a three to five-year perspective, as of April 9, 2019. The team has a moderately negative view of U.S. equities. It has a moderately positive view of emerging-market equities, European equities, Japanese equities and Canadian equities. In terms of fixed-income assets, the team has a neutral view of U.S. fixed-income assets and Canadian fixed-income assets during that time frame. It has a moderately negative view of European fixed income, and a bearish view of Japanese fixed income. However, the team has a positive view of emerging-market debt from a three to five-year perspective.
Table outlining the team’s views for each asset class. Short-term view for U.S. fixed income. Over the last 12 months, the key question relating to monetary policy has morphed from “how many more hikes?” to “are recent Fed cuts a simple policy adjustment or something more akin to a conventional easing cycle?” We currently anticipate two more interest-rate cuts by the end of the first half of 2020, but acknowledge that there is a distinct possibility of more aggressive easing should the macroeconomic backdrop deteriorate further. From a more strategic perspective, we believe the U.S. Federal Reserve (Fed) will opt for a prolonged pause once the current easing cycle has ended. This is why we expect longer-duration U.S. Treasuries to come under some pressure, but corporate returns are likely to remain favorable. We view high-yield bonds (HY) and leveraged loans more favorably than U.S. investment-grade (IG) debt. In our view, HY should benefit from the relatively benign interest-rate and credit environment. Short-term view for emerging-market debt. We expect emerging market central banks, particularly those in Asia, to embark on a sizable monetary easing exercise. This is particularly true in China, where monetary and fiscal policy is supportive of the asset class. From a strategic perspective, we think the quality of EM debt has been improving on a structural basis, and we view the asset class as a higher quality credit relative to U.S. HY and loans. We also favor the “carry” that the asset class offers. Within the group, we expect local currency sovereign debt to provide the most returns. Broadly speaking, we believe EM debt stands out from a total return perspective. Short-term view for European fixed income. As with the United States, the current picture in Europe is completely different from what it was earlier in the year. With the European Central Bank (ECB) having cut rates and engaged in another round of quantitative easing (QE), we expect European sovereign yields to remain anchored at current levels. From a strategic perspective, the “Japanification” of Europe (i.e., sustained deflationary pressure and weak demographics) could be problematic and keep a lid on rates and hamper growth. With the ECB having explicitly linked QE to inflation, we believe the central bank will either maintain its current level of policy accommodation or ease further over the next few years. Short-term view for Canadian fixed income. While the asset class benefited from lower global yields, we expect the Bank of Canada to follow other global central banks’ lead and eventually ease monetary policy. From a strategic perspective, we think Canadian rates should benefit from a stronger Canadian dollar (currency return), marginally higher rates (matching U.S. rates) over the medium term, and positive price returns. Returns for Canadian investment-grade (IG) bonds should match their U.S. counterparts, with mild currency appreciation potentially providing a modest benefit to Canadian IG issues. Short-term view for Japan fixed income. In the short term, we expect minimal movement in the country’s interest rates, barring any material appreciation in the Japanese yen. From a strategic perspective, we expect interest rates in Japan to remain at, or near, 0%, subject to some volatility. Inflationary pressure in the country is likely to remain negligible throughout our five-year forecast period, and we expect muted total returns in this asset class.
Table outlining the team’s views for each asset class as of April 9, 2019. Short-term view for U.S. equities. Trade policy uncertainty is weighing on consumer and business sentiment, which is beginning to filter through to hard economic data. While this softening at the margin is something that needs to be closely monitored, we maintain that the United States still has the best overall growth profile among developed economies. From a more strategic perspective, the United States has the healthiest macro profile in the developed world. Unfortunately, unsustainable valuation, profit margins, and sales growth point to possible relative downside risk that could hamper returns. Over the medium term, the U.S. dollar could also hurt the asset class’s returns as other economies’ currencies appreciate relative to the greenback during a cyclical upswing. Short-term view for emerging-market equities. We remain cautious about this asset class during the next few months due to uncertain global trade conditions, which are closely linked to EM earnings growth and market returns. From a strategic perspective, we think valuation remains attractive in the EM equities space with potential for further upside, driven by expectations for a structurally weaker USD in the long run. We believe this asset class retains the most attractive growth profile, which should provide attractive returns in the event of a global cyclical upswing. Short-term view for European equities. Despite the likelihood of short-term volatility due to geopolitical events (Brexit and potential trade tensions are top of mind) we believe that depressed valuations will revert back to higher levels as global manufacturing/trade impulse stabilizes. From a strategic perspective, our analysis suggests that valuation and dividend profiles for this asset class remain attractive; however, the investment case for European equities is partly counterbalanced by their weak growth profile. While an expected appreciation in the euro could translate into a tailwind, the ECB’s recent dovish turn is likely to cancel out any benefits from exchange rates in the medium term. On balance, we continue to view the asset class as being modestly attractive. Short-term view for Canadian equities. Valuation for Canadian equities remains bifurcated, with financials and energy trading at a discount while the other major industry groups are richly valued. Slowing global fundamentals also warrant caution. From a strategic perspective, an analysis of the dividend profile for Canadian equities suggests the asset class remains attractive over the longer term. The same can be said from a valuation perspective (particularly with reference to the energy and financials sectors, which make up about half of the index). Short-term view for Japan equities. There are reasons to be incrementally more optimistic about Japan: Earnings momentum has improved relative to other developed markets and, while not positive, some higher frequency data points suggest they’re stabilizing. While the consumption tax increase could be disruptive in the short term, we expect the government to be better equipped to insulate the effects of the hike than in previous instances. From a strategic perspective, structural factors in favor of Japanese equities include inexpensive valuation, continued improvement in corporate governance, and buybacks, which should provide a good counterbalance to the market’s modest growth profile. We remain mildly positive on the asset class.
Asset allocation's views on alternative assets. Short-term views of U.S. real estate investment trusts. Sentiment toward the asset class continues to be positive on the back of the Fed’s dovish stance and the potential returns on offer relative to investment-grade fixed-income securities—a not insignificant factor within the current “search for yield” environment. The promise of consistent cash flows against a backdrop framed by stable interest rates and declining equity growth forecasts can be very appealing. However, rising long-term interest rates remain the biggest relative risk for this asset class. From a strategic perspective, we expect U.S. real estate investment trusts to outperform modestly over a longer timeframe. From a yield perspective, we favor the asset class over many investment-grade bonds. Fundamentals supporting the asset class are likely to stay solid, but late-cycle concerns could continue to limit its appeal. Additionally, valuation for the asset class looks set to remain rich, even as growth slows. Short-term views of global natural resources. Oil is at the lower end of our rangebound outlook. Valuations for energy equities are attractive but more catalysts needed for investors to return to this unloved asset. From a strategic perspective, we expect the asset class to outperform global markets (including emerging markets) based on the potential for valuation expansion and high dividend yield. Expectations for higher oil prices, along with positive dynamics in gold and copper markets,  should provide additional support for natural resource equities. Short-term views of hard assets, or real estate in the United States and Canada. We expect income growth to remain above average, driven by generally strong demand fundamentals and a restrained supply pipeline. Although valuation gains have moderated from their peak earlier in the cycle, we expect these gains to remain near current levels given the strength of capital market activities and stable interest-rate outlook. From a strategic perspective, we have a favorable view of the asset class. In our opinion, its characteristics—income generation, stability of returns, low correlation with other assets and inflation protection—will continue to appeal. Specifically, we think the overall strength in underlying fundamentals and an environment that emphasizes “search for yield” will support continued gains in the North American real estate markets.

Index definitions

NCREIF Farmland Index
The NCREIF Farmland Index is a quarterly index that measures the performance of a large pool of individual U.S. farmland properties acquired in the private market for investment purposes only. The composition of the index can change over time—for example, when assets are sold, and when new Data Contributing members are added. As such, the Farmland Index may not be representative of the agricultural investment market as a whole.

NCREIF Timberland Index
The NCREIF Timberland Index is a composite return measure of investment performance of a large pool of individual U.S. timber properties acquired in the private market for investment purposes only. It is updated quarterly and is reported on a national level. The index is reported on a national level and is subdivided into three regions: the Pacific Northwest, South and Northeast. The composition of the index can change over time, and as such, may not be representative of the imberland investment market as a whole.

NCREIF Open End Diversified Core Equity ODCE Index
This is a capitalization-weighted, gross of fee, time-weighted return index with an inception date of December 31, 1977. Open-end funds are generally defined as infinite-life vehicles consisting of multiple investors who have the ability to enter or exit the fund on a periodic basis, subject to contribution and/or redemption requests.

MSCI/REALPAC Canada Quarterly Property Fund Index
The MSCI/REALPAC Canada Quarterly Property Fund Index covers unlisted open-end Real Estate funds operating in Canada. The index measures the investment performance at the property and fund level. The index is based on funds with a total net asset value of CAD $32.1 billion as at December 2018.

Cambridge Associates LLC Infrastructure Index
The Cambridge Associates LLC Infrastructure Index is a horizon calculation based on data compiled from 93 infrastructure funds, including fully liquidated partnerships, formed between 1993 and 2015. Private indexes are pooled horizon internal rate of return (IRR) calculations, net of fees, expenses, and carried interest.

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Nathan W. Thooft, CFA

Nathan W. Thooft, CFA, 

Co-Chief Investment Officer, Multi-Asset Solutions Team and Global Head, Senior Portfolio Manager, Asset Allocation Team

Manulife Investment Management

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Frances Donald

Frances Donald, 

Global Chief Economist and Global Head of Macroeconomic Strategy, Multi-Asset Solutions Team

Manulife Investment Management

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James (Jamie) Robertson, CIM

James (Jamie) Robertson, CIM, 

Senior Portfolio Manager, Head of Asset Allocation–Canada, and Global Head of Tactical Asset Allocation, Multi-Asset Solutions Team

Manulife Investment Management

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Sarah Lu, CFA, FRM

Sarah Lu, CFA, FRM, 

Senior Portfolio Manager, Asset Allocation Team, Asia

Manulife Investment Management

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Benjamin W. Forssell, CFA

Benjamin W. Forssell, CFA, 

Client Portfolio Manager, Global Multi-Asset Team

Manulife Investment Management

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