As we head towards 2020, expect a continuation, if not a deterioration, in the prevailing investment conditions as trade tensions and broader uncertainty erode economic growth and further destabilise markets.

Our just-released Vanguard economic and market outlook for 2020 points to a new age of uncertainty in the context of a continued slowdown in global economic growth, driven to a large extent by the unresolved trade tensions between the U.S. and China.

This, combined with unpredictable policymaking, is likely to weigh negatively on demand in 2020, and on supply in the long run as businesses defer new investments.

The global economy: Broader uncertainty

The global growth outlook is decidedly cloudy. Growth will remain subdued for much of the next year and, although we see U.S. growth decelerating below trend to around 1%, our expectation is that the world's largest economy will avoid a technical recession.

Meanwhile, we expect growth in China to drop below its 6% target rate to 5.8% and, in the euro area, growth will likely stay weak at around 1%.

For Australia, we expect a below-trend growth rate of 2.1%, with the domestic economy being cushioned to some degree by recent monetary and fiscal policy actions. "The pain of trade wars and other global uncertainty has been to some degree, alleviated by monetary and fiscal policy actions.

However, it is becoming increasingly clear in Australia that there are diminishing returns to further rate cuts and the overriding priority to achieve a budget surplus will likely limit the role fiscal policy plays at boosting activity in 2020," says Vanguard economist Beatrice Yeo.

"Doubts of a meaningful near-term resolution of the trade war between the US and China, coupled with continued geopolitical uncertainty and deterioriating industrial growth have resulted in a slowdown in growth in the world's two largest economies."

Inflation in Australia, alongside the euro area and Japan, is expected to undershoot the Reserve Bank's targets.

"In the absence of a strong solution to boost inflation and stimulate wage growth, we see a possibility for the deployment of QE-lite by the RBA or unconventional monetary policy of some form, once the cash rate hits 0.5 or even lower at 0.25 per cent," says Yeo.

Investment markets: Subdued returns here to stay

Investors should be mindful that as global growth slows there will be periodic bouts of volatility in the financial markets, given heightened policy uncertainties, late-cycle risks and stretched valuations.

"Our near-term outlook for global equity markets remains guarded, and the chance of a large drawdown for equities and other high-beta assets remains elevated and significantly higher than it would be in a normal market environment," says the global head of Vanguard's Investment Strategy Group, Dr Joseph Davis.

"High-quality fixed income assets, whose expected returns are positive only in nominal terms, remain a key diversifier in a portfolio.

"Returns over the next decade are anticipated to be modest at best. The fixed income return outlook has fallen further because of declining policy rates, lower yields across maturities, and compressed corporate spreads."

The outlook for equities has improved slightly from our forecast last year, thanks to mildly more favourable valuations, as earnings growth has outpaced market price returns since early 2018.

Annualised returns for Australian fixed income are likely to be between 0.5% - 1.5% over the next decade, compared with a forecast of 2% - 4% last year. The outlook for global ex-Australia fixed income returns is slightly higher in the range of 1.0% - 2.0%, annualised.

For the Australian equity market, the annualised return over the next 10 years is in the 4.0% - 6.0% range, while returns in global ex-Australian equity markets are likely to be about 4.5% - 6.5% for Australian investors, because of slightly more reasonable valuations elsewhere.

Over the medium term, we expect that central banks will eventually resume the normalisation of monetary policy, thereby lifting risk-free rates from the depressed levels seen today.

So, broadly speaking, given our outlook for lower global economic growth and subdued inflation expectations, risk-free rates and asset returns are likely to remain lower for longer compared with historical levels.

Tony Kaye
Personal Finance Writer Vanguard Australia
25 November 2019
vanguardinvestments.com.au