The global economic outlook was uncertain through much of 2019, with trade wars between the US and China and the UK’s impending departure from the EU all serving to spook investors. There have also been difficult conditions for some businesses, with slowing property prices and the retail sector’s long-term struggles coming to a head. This year has begun with growing tensions between the US and Iran that could lead to renewed turmoil in the Middle East.
PDI spoke to three professionals with three very different perspectives about the outlook for the global economy in 2020.
Wade O’Brien, managing director of capital markets research at Cambridge Associates, thinks the economic picture will vary between industries and enable savvy investors to target particular opportunities that will offer superior returns in a recession.
“Private credit may offer better options than public equivalents in 2020, but not all market segments are enticing. So-called ‘uncorrelated’ strategies – such as royalties, litigation finance, insurance-linked – typically aim for lower net returns than higher-beta peers, but should be insulated from slowing economic growth. If a recession ensues or market volatility picks up, credit opportunity funds, which lend to companies facing operational difficulties, may be able to charge higher rates and obtain some equity upside through warrants or other instruments. Lending funds focused on non-sponsored, mid-market transactions may be able to obtain better documentation and terms than funds targeting larger transactions.
“Distressed strategies may also be appealing, though anticipating when and for how long spreads will widen is difficult. One option is to allocate to private strategies that use a ‘drawdown’ feature, particularly those that wait to call capital until specific triggers are reached (such as higher spreads or weaker economic conditions). Downgrades to some of the lower-quality bonds could create opportunities for trading-oriented distressed funds. Investors would do well to have familiarity with both as they consider allocations for 2020.”
Nicolas Nedelec, managing director at Idinvest Partners, says many of the threats facing us in 2020 are similar to those in previous years, and that fund managers will already have incorporated them into their due diligence processes.
“One key concern for 2020 is a potential global slowdown on the back of the US/China trade war, political instability in Europe and tensions in the Middle East. However, investors have already lived with these threats throughout 2018 and 2019 and incorporated them into their due diligence processes. Central banks have proved that they would be willing to step in and prevent a brutal economic halt, and mid-market investors still benefit from better contractual protection (such as covenants) as well as sounder structures (such as average leverage of 4-5x with large equity cushions), meaning their portfolios should suffer less.
“The second major concern is the large amount of dry powder for private equity and private credit funds, which is pushing valuations and leverages up while there is a pressure to be looser on terms. Nevertheless, private markets overall are growing, matching the growth of AUMs for alternative capital funds. Private credit funds in particular benefit from the loss of market share of banks in the mid-market. And there is only a very limited number of new entrants now, meaning that the markets are stabilising somewhat.”
Ben Powell, a Singapore-based chief investment strategist for Asia-Pacific at BlackRock Investment Institute (BII), takes a contrary view to many. Referring to data the firm has produced analysing a number of key economic indicators, he believes the global economy may see a small recovery in 2020 and avoid a recession.
“We think that the line [Growth GPS – the indicator BII used to show that the consensus GDP forecast may stand in three months’ time, shifted forward by three months] is going to pick up. So the yellow line we think will start to move up in the direction of the orange line [referring to the rate of GDP growth implied by BII’s financial conditions indicator (FCI), which is based on its historical relationship with BII’s Growth GPS indicator, shifted forward by six months]. The list of financial conditions will be driven by a still resilient global economy, and particularly the US consumer driving demand. So it is still a robust consumer, services and employment picture. That – combined with looser policy, which obviously helped corporates and helps consumers – means US housing may be an interesting area over the coming year. A combination of robust growth in employment and wages, and lower mortgage rates, leads us to conclude that the yellow line is now aligned with where GDP is. This is going to start to stabilise and will then begin to appreciate.
“The growth, and the spectrum of it, has been very interesting for the last six months, as manufacturing has been really struggling while services have been okay. And the conversation has been ‘is the services sector going to come down to the level of manufacturing or will manufacturing start to pick up little bit towards the level of services?’ It has been a little bit of both. I have seen a little bit of weaknesses with services, but not too much. Now our call is that the manufacturing side, the export side and the trade side, given a period of relatively less tension over the next couple of quarters, can start to recover. And that is a big enough deal, particularly in Asia-Pacific, that GDP and the markets will perform a little bit better.”
Additional reporting by Adalla Kim