2019 has seen a continuation of the 2018 trend of decelerating global growth, but we believe this has likely troughed for key economies – think of it as a late-cycle pause rather than a slide into recession.
Inflation was missing in action in 2019, and we see no signs of a breakout anytime soon -- which should result in bond yields being lower for longer. During 2019 RARE reduced its long-term bond yield forecasts; we feel there is still a dispersion of market views on this topic, but participants are trending toward a lower yield environment.
Central banks continue to move to the accommodative end of the spectrum, and we see that trend continuing into 2020, anchoring yields at the lower end of recent trading ranges. We have seen a steady decline in the markets’ expectations for where bond yields will track over time.
Market Forecast of 10-year U.S. Treasury Yield in 2 Years
This could lead to a further expansion of earnings multiples for equities as the market factors in a lower cost of capital in the long term.
There is now general acceptance that monetary policy has become less effective, and that central banks don’t have the levers to offset a large downturn. Negative interest rates and QE are not the silver bullet to offset slower growth and virtually absent productivity improvements (jobs growth isn’t resulting in quality-of-life improvements anymore). However, fiscal stimulus has been slow and small in contrast to the slowdown that we’ve seen in global growth (Chinese stimulus, in particular, has been lackluster). We believe this has underpinned the global social upheaval that has been more prevalent in 2019 and will provide the backdrop for potential changes in the political landscape in 2020.
Political uncertainty and the shift toward nationalistic policies and approaches have created uncertainty for corporates and delayed investment decisions. Infrastructure has been spared this theme as regulators continue to approve projects driving near-record asset base growth and giving certainty to future earnings growth across the sector.
Market Perspective and Infrastructure Positioning
We are at the latter stages of the economic and market cycle. However, the market has been too pessimistic for growth for 2020 (particularly in the U.S. where in late 2019 we estimate that consensus had a 40% chance of a 2020 recession priced in) leading to a cycling toward growth and value from defensive stocks. We expect this to continue into at least mid-2020. However, we recognize the latter stages of a market cycle are characterized by periods of market volatility, and we have certainly seen that in 2018 and 2019.
The challenges to this upbeat thesis may come from:
- Underlying macroeconomic data not recovering as quickly as the market expects and hence pressure on earnings growth expectations (for example, in late 2019 earnings growth of 10% for 2020 in Europe seemed optimistic)
- Continued sensitivity around FX, with the eurozone and China both needing a lower currency, but weaker countries and EMs threatened by a higher USD... currency wars will likely continue ad infinitum
2020 will likely see increasing pressure on public policy from a range different, but connected directions – central banks will want fiscal stimulus for economies, climate change activists will continue to pressure for change, and populist groups will press for governments to ease cost of living pressures and begin to address wealth gaps. The direction and evolution of public policy will have critical implications for markets in 2020.
The importance of earnings growth and confidence that companies will not disappoint continues to support higher multiples in the infrastructure sector, which are now at the high end of the relatively tight trading range since the global financial crisis. Current multiples appear reasonable given confidence in the underlying growth in asset bases driving growth in earnings, cash flows and dividends across the sector.
Key Drivers for Infrastructure in 2020
We have seen a broader global acceptance of ESG principals in investing, with investors actively adjusting positions to take account of this. We believe the market has been too focused on the “E”, with not enough focus on the “S”:
- This is creating opportunities where companies operating “dirty” infrastructure are out of favor. For most of these companies, regulators approved the original expenditure and building of, for example, coal-fired generation, and will continue to provide appropriate returns on that investment.
- An upcoming challenge is the pressure placed on household bills from the speed of changing from fossil fuels to renewables
Infrastructure will likely continue to be in the headlines for all the right (and wrong) reasons. Global initiatives to reduce carbon emissions are resulting in local actions to support the continued development of renewable energy and drive toward greater electrification in the future. Governments are setting targets for renewable-energy-sourced electricity (EU 32% by 2030, California 60% by 2030, Virginia 0% carbon by 2050) and the Bloomberg New Energy Finance researchers expect 80% of new capacity growth through 2050 will come from renewables.
Meanwhile, significant capital is being spent to mitigate the effects of climate change and adapt networks and infrastructure to cope with more volatile climatic events (such as ice storms, wildfires), increase the efficiency of infrastructure (development of electricity storage) and reduce wastage (leaking pipes in water networks). This is driving near-record rate base growth across the sector.
We expect infrastructure to be the centerpiece of several governments' desires to stimulate their economies with the building of infrastructure utilizing local labor, local materials and improving the efficiency of local economies. The U.S. election campaign will likely see “green” infrastructure programs gain momentum.
Growth in the Slow Lane
Cautious Optimism Amid Change
Consumers Hold the Key
Looking Beyond the U.S.
Shifting the Global Balance
Uncertainty on the Horizon
Royce Investment Partners
Positive Signs for Small-Caps
Resilient Growth, Despite Risks
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