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Outlook from Principal® on critical drivers of investment performance

The global economy continues to recover from the COVID-19 related shock. We expect the recovery process to advance in Q4 2020 but at a pace slower than in 2020. Several sectors (travel, tourism, hoteling, commercial real estate) remain challenged as resurging COIVD cases has slowed return-to-work strategies. Another critical component is expiring fiscal support measures, which will challenge growth recovery unless renewed in a timely manner, particularly in the US where political compulsions are coming in the way of the CARES 2 fiscal package.

In their base case, our US Economists expect US real GDP to grow 26.1%QoQ annualized in Q3 2020, slowing to 7.2% in Q4 2020 which implies a contraction of -4.1% in 2020 GDP. They expect it to grow 3.5% in 2021, implying a full recovery of the lost GDP sometime in H1 2022.

The worst of the inflation decline is behind us. Our Leading Indicator predicts a gradual rise hereon, but nowhere near levels that can cause policy makers to turn hawkish. Structurally, inflation may get fresh legs if corporate consolidation leads to market share concentration (but that will happen only if weak hands are allowed to fail). Government policies that restrict international trade too can enable some pricing power to survivors.

  • Anti-fragile assets like global safe-haven treasuries and gold remain expensive.
  • Equity valuations are rich. While extremely depressed safe-haven yields remain supportive of equities, we could be getting close to a phase where valuations normalize i.e. markets rise far less than the forthcoming earnings recovery. 
  • Corporate spreads are in fair value zone, for both IG and HY. With help from monetary policy, they could tighten a tad but not a great deal. We don’t expect a meaningful widening either.
  • On the Currency side of things, the $ is still “expensive” based on purchasing power parity. A key condition for the US$ to weaken is stronger growth recovery outside the US, which will move money into under-owned assets in EMs and ex-US developed markets. A risk-off move, however, will cause the greenback to get even more expensive.

Central banks have delivered a lot but still seem “worried”, which is good for asset markets. If anything, they will err on the side of caution i.e. overstimulating the economy, which will keep risk premiums compressed.

At the end of August, markets were showing signs of euphoria which got corrected in September. Retail sentiment has become more subdued lately, and higher volatility implies the building froth in risk-parity and momentum strategies has ebbed. Markets are already pricing uncertainty due to a delay in announcement of US election results. Volatility implied by options on S&P 500 futures spikes up fairly steeply from 18% in early October to 27.5% in mid-December before tailing off to 23% in Dec’2023.  Overall, the technical indicators look finely balanced.

At this stage, the key risks we envision are:

  • A contested vote in US elections presents a serious risk for markets. A Democratic wave will almost certainly push up income taxes, though accompanied by a large infrastructure plan. 
  • COVID-19 recurrence hurts return-to-work strategies and stymies the recovery. 
  • Monetary/fiscal policy support is withdrawn too soon.
  • Prolonged unemployment payouts disincentivize workers, impacting potential labor supply.
  • Increased regulation of the technology sector.
  • Social stress caused by COVID-19 could manifest itself in bouts of unrest, dampening the recovery.

As of 30th September 2020. These are the current views and opinions of Principal Global Asset Allocation and is not intended to be, nor should it be relied upon in any way as a forecast or guarantee of future events regarding particular investments or the markets in general

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This document has been prepared by Principal Global Investors for informational purposes only. The contents of the document should not be construed as an advice on legal, financial or regulatory issues. No person should rely on the contents of this document without first obtaining independent advice from qualified professionals. The National Bank of Ras Al Khaimah (P.S.C), its employees and consultants expressly disclaim all liability and responsibility to any person who reads this document in respect of anything done or omitted to be done by such person in reliance, whether wholly or partially, upon the contents of this document and shall not be responsible for the results of any actions taken on the basis of information provided in this document or for any error in or omission in this document.