We begin the new decade riding a historic economic expansion that enters its 11th year. 2019 saw global stocks post significant gains and bond markets rally for most of the year as the dominant obstacles retreated or moved closer to resolution. At this point, our economic and financial outlook for the coming year remains modestly optimistic:
- Tensions are cooling in the US/China trade war
- Global central banks have taken steps to ease monetary policy
- Global growth is poised to rebound, reducing fears of US or worldwide recession
- The indefatigable American consumer persists as a bulwark supporting the global economy
Our optimism is tempered by the likelihood that a reversal of any of these factors would lead to market declines. We also expect the coming year to bring greater volatility, although absent any fundamental deterioration of these factors, we would view any pullbacks as buying opportunities. With the potential for pitfalls, it is especially important for investors to monitor economic reports for any signs of weakening and be prepared to make quick adjustments or maintain more balanced portfolios.
In the US, the economy demonstrated its resilience with the previous quarter projected to grow 1.8%. Despite predictions from pundits that the trade war would lead to recession, the economy withstood the negative impact on the manufacturing sector from the tariffs. Indeed, the ISM Report on Business showed US manufacturing contracting in 5 consecutive months to end the year. However, service activity remained robust with PMI readings solidly expanding. The scorching labor market has shown no sign of slowdown and headlines the positive case for the US economy. The US added on average 177,000 jobs per month in 2019 and job growth accelerated into the end of the year. Unemployment is the lowest it has been in 50 years and wages are growing about 3%. The Federal Reserve restored accommodative monetary policy with three quarter-point rate cuts in 2019 and Chair Powell has signaled that it would take a significant increase in inflation or economic activity to force rate hikes. We expect the newly-dovish Fed and the strong consumer will prevent the US from slipping into recession, but we are hesitant to anticipate a new upward cycle of growth. We forecast that the US economy will maintain its 2019 pace of about 2% in 2020, with inflation hovering around 1.9% – 2.0% and unemployment holding steady.
How will U.S. stocks follow up its tremendous performance in 2019? The S&P 500 finished the year up 31.5%. However, earnings growth will probably come in negative in 2019 after the final tally. That means that the stock gains further stretched P/E multiples to the limits of what could be called fairly valued. It is difficult to imagine further advances without a pickup in corporate earnings. While the resilient economy will bring a return to earnings growth, profit estimates for this year have fallen from double digits to about 9%-10% improvement over last year’s numbers. However, higher labor costs, continued effects of remaining tariffs, and uncertainty from the upcoming election will skew the risks to this forecast to the downside. With already high multiples on stocks, our conclusion is that broad indexes will track or slightly lag earnings growth and finish the year about 6%-9% higher. In this middling environment, investors should focus on sectors and companies that benefit from secular trends that are sheltered from economic headwinds.
The global economy, which experienced a synchronized slowdown in 2019, is forecast to recover modestly this year. The International Monetary Fund (IMF) attributes the subdued growth last year primarily to increased tariff barriers and elevated uncertainties surrounding trade and geopolitics. Especially hard hit was capital spending and manufacturing. On the other hand, broad-based monetary stimulus implemented by the world’s leading central banks partially offset these negatives. Heading into 2020, the Phase 1 tariff agreement between the U.S. and China, the USMCA treaty, and greater clarity towards a Brexit solution should improve prospects for capital spending, manufacturing, and trade. Meanwhile, we expect global central bank accommodative policies to continue well into 2020. We echo the IMF global GDP projections of 3.0% in 2019 and 3.4% in 2020, which is still below the 3.8% gain in 2017. Fueled by monetary stimulus, this economic recovery will support higher global equity markets as the fears of recession that rattled financial markets earlier in 2019 diminish.
Our confidence in international stock markets is based primarily on the improved outlook for corporate earnings, subdued inflation, low bond yields, and very attractive valuations. We do not expect developed country economies (notably the Euro Area, Great Britain, Canada, and Australia) to rebound strongly: improved global conditions will likely result in modest GDP growth of only 1-2%. However, even such a mild rebound in output will support earnings growth and a corresponding stock market advance. Companies in developed country economies with strong bottom-up fundamentals will outperform, especially in consumer and technology sectors. The brightest spots in the global economic outlook are the emerging economies. The latest forecast of the IMF foresees a growth pickup from 3.9% in 2019 to 4.6% in 2020, including 5.8% in China and 7.0% in India in 2020. We are also projecting a rebound in Brazil from about 0.7% to 1.5-2.0%. This combined economic advance will come as a boost to emerging markets: over the past 5 years the iShares MSCI Emerging Market ETF (EEM) was up a meager 16.3% in comparison to the 57.4% jump in the S&P 500 Index. Additionally, a stabilization or decline in the dollar, which we consider likely, would be another positive for international markets.
The bond rally of 2019 peaked in September with the 10-year US Treasury rate nearly reaching its all-time low. Bonds yields have come up ever so slightly from their lows as global growth appears to have stabilized. We forecast a slight progression higher for interest rates that will track the pickup in growth. The synchronized efforts of global central banks to ease monetary policy will limit the potential for a significant advance in rates absent an unexpected spike in inflation. High-quality, short duration bonds continue to provide a haven for capital preservation but we caution against reaching too far with lower rated or longer dated bonds as those carry risks that would be better allocated in the equity markets.