Trade Troubles Persist as Central Banks Resist Recession...Trade Troubles Persist as Central Banks Resist Recession October 2019 Global equities rose in September, recapturing some

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Voya Multi-Asset Perspectives

Trade Troubles Persist as Central Banks Resist Recession

October 2019

Global equities rose in September, recapturing some of August’s losses. By contrast, so-called “safe-haven” fixed income asset classes, such as long-maturity U.S. Treasurys, declined, giving back a small portion of their prior month returns. The advance in stocks was led by the UK and Japan; additionally, U.S. value stocks outperformed growth stocks. The shift from defensive to cyclical stock leadership came alongside a short-lived lift in long-end U.S. interest rates. The temporary jump in term premium and yields followed the first increase of the global PMI index in 16 months, as the bond market began pricing a potential end to the cyclical slowdown. Unfortunately, subsequent data would show that an end has not yet come.U.S. ISM manufacturing PMI’s recent print of 47.8 was a 10-year low. New orders and exports continued to ebb, pointing to further weakness likely in 4Q19. This coincides with a drop in manufacturing employment growth. Eurozone economic data also remain soft, though consumer confidence may be firming. This comes on the heels of the better September employment report, which showed the region’s unemployment rate continued its six year fall. The German unemployment rate is down to 5%, much improved from the peak of 12.1% in 2005.

Against this backdrop of softening economic growth, monetary policies are easing. For the second straight month, the Federal Reserve lowered its benchmark rate by 25 basis points (bp) in September on a weakening outlook and below target inflation. Outgoing European Central Bank President Mario Draghi, whose term officially concludes at the end of October, finished his tenure with a fresh round of stimulus, including a modest rate cut and a new open-ended asset buying program. He urged European governments to increase fiscal spending to take pressure off monetary supports. Emerging market central banks are cutting rates aggressively. While global monetary policy is generally expected to become more accommodative in the ensuing months, much of the prospective rate cuts may already be priced into asset markets.

Figure 2. Present and future confidence remain high despite their divergence

Figure 1. U.S. labor market conditions remain strong

Economic Growth (neutral):Growth is slowing but still positive

Fundamentals (neutral):Estimates of 3Q19 earnings growth are negative, but revenue growth is expected to hold up

Valuations (neutral):Valuations on stocks appear reasonable from historical and cross-sectional standpoints

Sentiment (neutral):Market sentiment has degraded and is near oversold levels

Source: JP Morgan, Bloomberg, Voya Investment Management, as of 9/30/19

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JP Morgan Global Composite PMI Contraction/Expansion BoundaryOECD Slowdown

Source: Atlanta Federal Reserve, Bloomberg, Voya Investment Management, as of 9/30/19

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9De

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Figure 3. If you want to know where bond yields are going, look at Germany

Source: Bloomberg, Voya Investment Management, as of 10/3/19

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Indexed 10-year yields: U.S. Treasury versus German Bund, October 2013 = 100

PMIs are leading indicators of economic growth

Conference Board: future versus present confidence

Voya Multi-Asset Perspectives | October 2019

Investment Outlook The industrial slowdown in global activity, which began in 2018 (Figure 1) as China started rebalancing toward a more consumer oriented economy, has been exacerbated by trade tensions and is threatening to induce a recession. Industrial activity is a prominent leading indicator that often acts as a swing factor for global growth. As a result, it frequently provides the thrust for equity market performance, which can flow through into the services sector and personal consumption. Although the Conference Board’s Consumer Confidence survey shows that consumers’ assessments of their present situations are still solid, these headwinds are weighing on the expectations component (Figure 2). Still, we are cautiously optimistic and watch closely the trends in labor income and hours worked for signs of consumer wellbeing.

Despite the challenges and assuming no significant escalation of the trade war, we believe services sector U.S. payroll growth will hold up. We are also encouraged to see historically high U.S. savings rates, which should smooth downside deviations of income. Most importantly, global central banks seem committed, albeit publicly hesitant, to providing a backstop with the vast majority currently in easing mode. In addition, many global central banks are employing stimulative actions; China has recently cut its reserve requirement and continues to pursue targeted stimulus measures. These steps have intensified China’s credit impulse, which tends to lead global economic activity and provides us with hope that monetary policy can still be effective, even if it has become less efficient. Outside the United States, there seems to be more scope for fiscal support, and in Europe, there is a serious need. Nevertheless, we think more internal pressure or pain will be required to convince Germany to depart from its deep-rooted conservative predisposition. Spending for the benefit of Italy and other struggling European countries should ultimately help them, but it is a difficult political sell.

Our portfolios remain modestly overweight stocks, which we view as relatively attractive versus fixed income given our outlook for low, slow, but still positive economic growth. Yet, we recognize the risks facing our positioning and the high probability that the gravitational pull from extraordinarily low foreign developed-market bond yields will drag on U.S. yields (Figure 3). Thus, we lengthened duration to neutral in fixed income portfolios following the sharp rise in yields at the beginning of September. We balanced this trade with a lessening of a long held underweight to U.S. small-cap stocks at the tail-end of the vicious defensive versus cyclical stock unwinding. Despite the violent reversal, the valuation gap between large and small caps is near historical extremes; we believe this gives small caps an opportunity to close the distance.

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Portfolio PositioningEquities

U.S. Large Cap Reasonable valuations and resilient earnings create relative attractiveness versus fixed income

U.S. Mid Cap Late cycle and full valuations offset decent, near-term earnings outlook

U.S. Small Cap Relative valuations compared to large cap are alluring, but susceptible to increasing operating costs because of high leverage

International Equities Relatively slow growth, volatile political backdrop and fragile European banking system

Emerging Markets Equities FOMC policy action not as supportive as markets hoped; U.S. dollar strength a near-term headwind

REITS May act as a buttress during high levels of volatility due to their yield attractiveness and healthy fundamentals, but cap rates are low

Fixed Income

U.S. Core Fixed Income We favor quality investment grade bonds over high yield given the late stages of the credit cycle and move to a neutral duration posture

Non-Investment Grade Favor high quality fixed income; tight spreads, illiquidity concerns and limited yield advantage make loans more attractive than high yield

International Fixed Income Low absolute and relative yields lead us to favor U.S. bonds

Underweight Neutral Overweight

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Voya Multi-Asset Perspectives | October 2019

Past performance does not guarantee future results.

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Multi-Asset Strategies and Solutions Team

Voya Investment Management’s Multi-Asset Strategies and Solutions (MASS) team manages the firm’s suite of multi-asset solutions designed to help investors achieve their long term objectives. The team consists of 25 investment professionals who have deep expertise in asset allocation, manager selection and research, quantitative research, portfolio implementation and actuarial sciences. Within MASS, the Asset Allocation team, led by Barbara Reinhard, is responsible for constructing strategic asset allocations based on its long-term views. The team also employs a tactical asset allocation approach, driven by market fundamentals, valuation and sentiment, which is designed to capture market anomalies and reduce portfolio risk.Paul Zemsky, CFA

Chief Investment Officer, Multi-Asset Strategies

Barbara Reinhard, CFA Head of Asset Allocation,Multi-Asset Strategies