The global economy has shifted into a lower gear in the past few quarters. Following a period of a strong and broad-based economic momentum, soft spots in the economy emerged in the second half of 2018 and continued into 2019. Growth decelerated across the board, with more pronounced weakness among countries and sectors where trade and manufacturing play an important role. The slower growth fits into a dynamic of high (and rising) policy and political uncertainty, which weighs on global investment and confidence. Slower growth is also caused by ongoing trade tensions.
Whether the slowdown is temporary or whether it will drag on depends on a number of binary events like the trade tensions and Brexit. This year's Long Term Outlook from the Multi Asset Group of Aegon Asset Management (Netherlands) considers two – equally likely – scenarios. In the positive scenario, growth in the coming years remains close to the current level. This scenario is likely to materialize if the trade dispute does not worsen, and if the recent weakness in the manufacturing sector does not persist. In the absence of adverse shocks, the cycle can continue in the coming years. Still, we foresee slower growth in comparison to previous years as capacity constrains in pockets of the economy have intensified. In this positive scenario we expect global monetary policy to remain accommodative – possibly in combination with a fiscal impulse – to support growth in the near term. In this scenario fixed income investments have relatively low expected returns, with somewhat higher returns for higher risk categories within the fixed income space. Our return outlook for equities in the positive scenario is in the mid-single digits spectrum, roughly in line with historical averages.
In our negative scenario, we account for a growth slowdown in the near future. The loss of economic momentum could be driven by various factors, of which a further escalation of the trade dispute is among the most likely and impactful. The adverse effects of trade uncertainty could disturb the economy via various channels, the confidence and investment channels in particular. Given the nature of these possible headwinds, we expect open economies to face more adverse effects in the near future. Other factors that have the potential for the negative scenario to materialize are related to Brexit, as well as a broadening of the manufacturing weakness, spilling over into the wider economy. In this scenario we expect labor market weakness, ending the strong employment trend that pushed the unemployment to current lows. We foresee a quick reaction function from central banks, easing conditions further – where mainly the Federal Reserve is well positioned to counter the slowdown. This results in relatively low returns for most fixed income assets. The economic slowdown results in a revaluation of higher risk assets, causing negative returns for most equity categories.
Strategic Asset Allocation Decisions
The strategic asset strategic allocation for a range of Aegon Asset management funds has been adjusted to reflect our market views and return expectations for the period 2020-2023. We ensure the asset allocation is robust by including the return outcomes of a negative and a positive scenario in our portfolio construction process.
Given the two scenarios presented above, we favor alternative fixed income assets, resulting in an overweight in Dutch mortgages and European Asset Backed Securities. Also, we have implemented a small overweight towards high yield corporate bonds. Our analysis reveals that these asset classes are attractive on a risk adjusted basis, taking into consideration our macroeconomic outlook, expected returns and (asset class specific) risk assessments. All overweighs are implemented at the expense of the core Eurozone government bonds allocation.
Many asset classes offer not enough compensation to warrant an overweight in the strategic asset allocation. Valuations are relatively rich and the economic situation is uncertain. The most notable exception to this observation are Dutch mortgages where the current credit spreads is more than enough to compensate for any potential losses in any scenario. For many other asset classes, we prefer to stay close to neutral weights, such that we can change the allocation when better opportunities arise.