2020 Market Outlook: Modest Economic & Market Growth Ahead
Mark Simsenstad, CFA, Chief Investment Strategist | January 7, 2020
Although the stock market enjoyed a strong year in both the U.S. and abroad in 2019, global economic growth in 2019 was disappointing versus expectations at the start of the year. This was undoubtedly a factor in the decline in intermediate and long-term interest rates both domestically and internationally. It also meaningfully altered the forecasts of global central banks regarding the need for additional restrictive monetary policy actions. In fact, more accommodative policies were adopted across the globe.
Slower economic growth resulted in more moderate or even negative earnings growth for many equity markets. The strong performance by most indices was largely a result of higher price/earnings ratios a function of the decline in interest rates which offset the modest growth in earnings.
The disappointing economic growth was largely attributed to weakness in the manufacturing sectors of the global economy, which was considered a function of the uncertainty surrounding unsettled trade and tariff disputes.
Additionally, Great Britain leaving the European Union, as well as its inability to resolve its Brexit issues added to the uncertainty. Both of these factors impacted the manufacturing sector and contributed to the unwillingness of companies to make investments and long-term strategic commitments.
Balancing the weakness in manufacturing were continued strong readings from the service sectors, strong employment data and inflation well below or in line with expectations of central bankers.
As we end 2019, progress on both trade and Brexit appear to be at hand. A "phase one" agreement on trade and tariffs between the U.S. and China appears in place while the recent election results in the UK appear to have set the table for Brexit to advance. While each of these items have positive and negative consequences for segments of the respective economies, it reduces uncertainty and may remove impediments to investing and growth opportunities.
We expect macro data points to improve slowly through 2020, with growth stabilizing early in the new year and accelerating into the second half. This would be consistent with the reduction in uncertainty referenced above, as well as the traditional lead/lag times of changes in monetary policy. This is particularly true in the context of continued low inflation, low interest rates, strong consumer positions, and strong employment data.
For U.S. Treasury yields, we expect an upward drift from current levels in intermediate and long-term rates. We expect the 10-year U.S. Treasury to remain in a range of 1.5% to 2.5% versus the year-end levels of around 1.9%. That rate reflects a sharp increase in a relatively short time frame from the 1.46% low in September 2019 a move that suggests that the market anticipates a resurgence in economic growth.
Analyzing Fixed Income Risk
In terms of risk positioning, our concern is that interest rates would move up sharply rather than to move lower. The catalyst for that scenario might be an unexpected acceleration in economic growth or a negative surprise in the inflation rate. In the absence of any economic or inflation surprises, we expect the Federal Reserve (Fed) to leave rates unchanged throughout 2020.
We expect the yield curve to continue to steepen, with long rates increasing faster than short rates, versus the very flat levels that prevailed in 2019. The lack of a premium for longer term securities comes amidst an environment that has been inconsistent regarding risk-taking. A steepening yield curve indicates an expectation of an increase in economic activity and low recession expectations.
Additionally, we have seen a relatively narrow credit spread the difference between credit-risk-free Treasury securities and corporate bonds, which have default or downgrade risk. As a result, the premium earned for taking credit risk is relatively low. That too, is consistent with an environment of continued economic growth and low recession risk.
Are Earnings Growth Estimates Too High?
Earnings growth expectations for the S&P 500 are currently in the mid to high teens for 2020. We believe that is unrealistic. It suggests an acceleration in revenue growth and margin expansion that we find difficult for corporate America to achieve.
That said, we do see positive earnings growth for 2020 and a modest upward trend in interest rates. Although valuations are currently high, in the absence of a recession, we expect continued equity growth in the U.S. market this year in the mid to high single-digit range.
We see solid potential in the domestic small cap and value markets, particularly in the context of an acceleration in global economic growth. Consistent with that outlook is a bias toward international equities particularly in Europe and in the emerging markets. Those markets reflect characteristics similarly leveraged to an improved outlook for global growth.
For U.S. equity investors, an important factor this year may be the outcome of the presidential election, which is too close to call at this point. Putting aside the noise of political rhetoric between the candidates, there will likely be significant policy differences regardless of who the final candidates turn out to be. As the race becomes more well-defined, those differences may manifest themselves in sector, industry or market index performance. Stay tuned for more on this issue.
Wishing you all happiness, prosperity and success in the New Year!