First Half Outlook 2020
Updated: May 1, 2020
After a record-breaking year in 2019, find out what our team of financial experts predicts for 2020. High consumer sentiment, the US/China Trade Deal, and policies from the Fed are just a few of the highlights.
"Overall, 2020 looks likely to begin with more of what we’ve seen so far in this expansion— just slower."
The End of a Decade
As we close the chapter of another decade, we are happy to report that 2019 was an exceptional year in the financial markets. Despite the relentless news coverage of trade wars, impeachment hearings, and inverted yield curves, to name just a few, the markets rallied due, in part, to a resilient consumer and accommodative Central Banks around the world. Two major forces driving the markets throughout the year were:
The U.S./China trade war
The U.S. Federal Reserve and interest rates.
The Fed did a complete reversal from their policy in 2018 (where they raised rates four times), and then cut rates three times in 2019. This tailwind helped propel markets to record highs. The U.S. and China made progress in their trade negotiations with “Phase One” of the trade deal. Although this did not include some of the larger trade issues being discussed, the markets seemed to applaud any lack of negative news on this front. Going forward, competing positive and negative forces will continue to work both for and against the U.S. and global economies and markets:
The U.S. economy likely will remain bifurcated—at least to start the year—with beleaguered manufacturing and business investment, but healthier services and consumer spending.
Easy monetary policy should carry over to 2020; but it may be of little help to ongoing trade and political uncertainty.
The recently announced Phase One trade deal between the United States and China could help stabilize manufacturing/business investment; but corporate optimism is likely to be subdued in this uncertain environment.
Given these factors, the base case is for continued slow growth through
2020. Corporate revenue and earnings should continue to increase, possibly by more than most analysts expect. If growth trends meet expectations and confidence levels remain steady or improve, we would expect positive results in the year to come.
Manufacturing Weak, but the Consumer Remains Strong
As we head into 2020, we will continue to focus on what has been a fairly firm dividing line between the manufacturing/business investment side of the economy and the services/consumer spending side. Company CEOs’ forward-looking confidence is currently at low levels; while consumer expectations remain near historic highs, and the spread between the two has rarely been wider historically.
The deterioration in global growth throughout the course of 2019 was more severe than expected, led by the manufacturing sector. We believe that increasing policy uncertainty was the primary driver of this deterioration—specifically, trade tensions related to tariffs, especially between the United States and China, and Brexit negotiations.
With continued geopolitical uncertainty and unpredictable policymaking, these influences may weigh negatively on activity during the coming year. Conversely, the U.S. labor market has significant momentum heading into the new year, with the unemployment rate at a 50 year low, and payrolls growing at a robust pace. Unemployment claims have recently ticked higher, however, still at historically-low levels. Unemployment claims bear close scrutiny heading into 2020, as they typically carry signals for the future health of the labor market. They are also a leading economic indicator and could provide insight into the health of the overall economy. We’ll keep you posted.
Deal or No Deal?
Although a “Phase One” trade deal has been agreed to by the United States and China, it falls quite short of the initial U.S. goals of forcing China to morph its state-driven economy to a more open/fair economy. It does, for now, defer the tariffs that were set to go in effect on December 15, 2019, which targeted a mass of consumer oriented goods. In addition, there was a partial roll-back of prior tariffs imposed last September getting cut from 15% to 7.5%. The “original” 25% tariffs on $250 billion of Chinese goods, however, remain in place.
China also agreed to increase its purchases of agricultural products to $40 billion, up from its current annual run rate of less than $10 billion (and the all-time peak of $29 billion). Finally, China has promised to revise some laws and regulations on foreign investment and intellectual property (IP); but it doesn’t prevent China from continuing to “import” (aka “steal”) U.S. IP through its powerful technology ecosystem. One would expect this major issue to be addressed in Phase Two.
The deal also doesn’t mean the Trump administration won’t continue to use tariffs and other trade barriers as a tool to coerce various concessions from, or to punish, other countries. This ongoing uncertainty is likely to dampen corporate confidence—and in turn capital spending. Even with trade tensions somewhat reduced, corporate confidence may remain muted in what is likely to be a very contentious election year.
Fed to the Rescue
Courtesy of monetary policy and financial conditions, 2019 was the just opposite of 2018. In 2018, although earnings growth skyrocketed thanks to corporate tax cuts, stock market valuations (i.e. price/earnings (P/E) multiples) contracted because of the weight of tighter monetary policy and financial conditions. However, when the Fed moved to easing mode in 2019, financial conditions eased as well; allowing P/E multiples to expand—even without the benefit of earnings growth in 2019.
The Federal Reserve’s three interest rate cuts in 2019 clearly supported asset prices, and they are currently expected to stay “on hold” in 2020. In fact, with slower economic growth and inflation only around 1.5% to 2%, the Fed may cut rates further if we see any weakening in the economic data.
Earning Needed to Support Prices
For now, the Fed’s position supports the intra-cycle slowdown thesis as well as the equity market. However, the tailwind behind P/E multiples may have run its course. Most valuation metrics, including P/Es, are stretched relative to history; and now likely require earnings growth to begin to support these higher valuations. According to Refinitiv, S&P 500 earnings growth is expected to rebound back into double-digit territory by the second half of 2020; but estimates have been trending down for several months.
The remaining question concerns valuations. Through most of 2019, high levels of consumer confidence drove market valuations higher. If confidence continues, this market may still have room to run, but downside risk exists if valuations drift down closer to historical averages.
The International Markets
From a market perspective, valuations appear, by some measures, cheaper abroad, which could lead to international markets outperforming those in the U.S. However, with reward there are risks on the international front. The trade war, if not resolved, will continue to weigh down global growth and markets, as would a U.S. recession. International markets are likely to deliver both higher potential reward and risk than U.S. markets in 2020.
2020 Outlook and Positioning
This time last year the markets were just beginning to recover from a sharp sell-off during the fourth quarter. In last year’s newsletter we commented that “lower stock prices and lower expectations heading into the year make a great case for further stock gains in 2019.” That turned out to be correct, however, going into 2020 we’re facing the opposite situation: higher stock prices and higher expectations. The U.S. stock market is currently near record levels with the expectation of improving corporate earnings. With this set up going into 2020, we are cautious about the year ahead. We are tactically neutral on equities—which means we continue to recommend investors stay at their long-term strategic allocation to equities, while using volatility to rebalance back to those long-term targets.
Throughout 2019, we’ve emphasized our overweight to U.S. stocks vs. International stocks as the international markets had more uncertainty and potential volatility than their U.S. counterpart, in our opinion. Despite significant outperformance of the U.S. markets in 2019 and subsequently higher valuations, we’re maintaining this overweight position in U.S. equities going into 2020 due to our continued concerns around economic growth and volatility in the international markets.
Our fixed income strategy changed considerably in 2019 when it became apparent to us that the Fed was about to change course regarding its interest rate policy. If you recall, in our core fixed income allocation we favored short-term Treasuries during the period of rising interest rates back in 2018. In 2019, when the Fed changed their interest rate policy and indicated that they may start cutting interest rates, we moved out of Treasuries and favored a more diversified fixed income allocation of high quality bonds with longer maturities (and duration). This was particularly helpful in 2019 as interest rates fell throughout much of the year. Going into 2020, it appears the Fed is on hold regarding interest rates, and thus, we do not see the need to adjust our fixed income allocation for the moment.
Finally, our Hybrid or Alternative allocation is becoming an increasingly important part of portfolios. As the stock market continues to make record highs and the bond market looking increasingly expensive (i.e. low yielding), we attempt to find higher yielding, but lower volatility solutions that are potentially not as correlated to traditional stocks and bonds. We are using real estate investments and various credit strategies to fill this bucket, and are continually looking for other solutions to help enhance portfolios. We attempt to balance liquidity, volatility, return potential and many other factors in determining this important component to overall asset allocations.
The past year was an eventful one, particularly in terms of the political risks. Still, the economy and financial markets continued to grow, as the underlying fundamentals remained sound. The fundamentals may be weakening, but the most likely outcome appears to be continued slow growth. Even if growth becomes muted (both here and abroad) or any other issues (known or unknown) emerge, the underlying strength of consumer spending should help mitigate the damage. Overall, 2020 looks likely to begin with more of what we’ve seen so far in this expansion— just slower. Slower economic growth and slower market appreciation. Despite the rising risks, which have the power to change things very quickly, we’re cautiously optimistic of what lies ahead in the year to come.
We continue to focus on building high-quality, durable portfolios tailored to your individual long-term goals & objectives. Our strategic approach to asset allocation, diversification and manager selection attempts to balance your portfolio’s ability to weather the storm during turbulent markets, yet participate when times are good. As always, your ISG investment team will keep a close watch on the global financial markets and will reassess the data and our investment strategies as necessary. We sincerely thank you for your continued confidence and trust in us.