In terms of returns, 2019 was kind to investors with asset prices having generally risen. This is true of equities - with the FTSE World Index enjoying healthy double-digit growth (at the time of writing in mid-November) - and of fixed income, with global bond yields touching lows not seen for many decades, giving investors positive capital returns.
Yet the economic backdrop was not so positive: growth slowed to its weakest pace since the financial crisis, with the International Monetary Fund predicting annual global GDP growth of just 3% in 2019.
There are reasons for this slowdown. We have seen a fall in business confidence and with it declining capital expenditure. 2019 has also been characterised by trade frictions - whether between US/Europe, US/China or UK/Europe. These are not going to go away and we expect them to continue to weigh on bond markets in 2020.
What could be different in 2020 is how central banks respond. There may be less room for monetary easing, particularly as some central banks reduced rates quite aggressively in 2019. The US Federal Reserve cut rates three times in 2019 and, with rates reduced to a range of 1.5% to 1.75% following October's cut, few are predicting anywhere near as many - if any - cuts in 2020.
NEW FORMS OF STIMULUS?
Instead, 2020 may be the year that central bankers have to evaluate whether their policies of negative yields are working. The theme of the year could be one where central bankers question their policy tools and start to look to new alternatives to stimulus, such as targeted lending or targeted spending on infrastructure.
We also think 2020 could be the year where more governments look to fiscal stimulus programmes to spur growth. We expect Christine Lagarde might, in her new role as head of the European Central Bank, lobby European governments to increase spending to boost their economies, a move which would impact bond markets.
This possibility of increased government stimulus is a sign of growing recession risks in developed markets. We believe Germany, the US and the UK (depending on the outcome of Brexit), are particularly at risk of recession in 2020. Political risk is also elevated with impending US elections and continuing turmoil in China and Hong Kong
Against this backdrop, we think bond investors should seek out safe havens in 2020. This is a difficult task given widespread negative yields. Europe, for example, accounts for around 30% of the global bond market by value but only 7% of its yield.1
So, what should bond investors do? Given how yields have fallen further over the last year, it is even harder to find safe haven bonds with decent, or even positive, yields. German Bunds, which trade on negative yields, are a prime example of how there is often a cost to holding safe haven bonds.
Default risks are also a growing concern. Given the uncertain economic backdrop, we see default risks rising in certain jurisdictions next year. We expect the default rate on US high yield bonds to climb to 3.8% next year from 2% currently,2 driven partly by problems in the energy sector. Investors should take note.
Then there is risk of deleveraging in China. If this becomes disorganised it would affect all markets, but emerging market bonds would be particularly negatively affected.
Amidst all these risks, we are on the lookout for alternative safe havens: investment-grade corporate bonds with low risks of default yet with decent positive yields.
The consumer services sector is a good option. While there are heightened risks of industrial, trade and manufacturing weakness in 2020, this does not necessarily mean there will be a consumer recession. Indeed, only about half the time does a recession also lead to weakness in the consumer sector.
With their footings of healthy income and modest leverage, the consumer sectors are in a strong position. In 2020 we will be searching out opportunities among asset- and mortgage-backed securities and domestically-focussed telecoms, utilities and food and beverage companies, many of which are paying down debt and whose bonds offer positive yields.
CHARTS TO KEEP AN EYE ON IN 2020
SHARE OF GLOBAL BOND MARKET VALUE
Source: Bloomberg Barclays Bond Indices, 2019.
SHARE OF GLOBAL YIELD
Source: Bloomberg Barclays Bond Indices, 2019.
1 Source: Bloomberg Barclays Bond Indices, 2019.
2 Source: Columbia Threadneedle Investments, 2019.
Read more of our investment teams' outlooks at columbiathreadneedle.co.uk/2020
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