Expectations - Good news may be already baked into the market and equities may be in for a bumpier ride in 2020
Six months ago, fears of a possible recession surfaced due to falling manufacturing levels, acute trade concerns and an inverted yield curve. Sentiment has improved markedly since then, and the second half of 2019 saw strong a strong come-back from the year-end 2018 lows for equities and other risk assets.
2020 has started in a risk-on mode with investors, despite a short-lived setback in stock prices and a spike in oil related to rising U.S./Iran tensions. Investors largely shrugged off rising tensions in the Middle East, evidence of a more mature investment cycle as investors seem increasingly confident. Investors don’t seem over-confident at this point, with neither a recession nor tighter monetary policy on the horizon, but we do think they may be looking past ongoing risks.
For most of the past decade, we have adopted a generally bullish stance toward the economy and equities. But today, we are less enthusiastic about the outlook for corporate earnings and profits growth and think markets may be short-term overbought, and hence, overvalued. Manufacturing and trade levels are improving, but this progress is marginal and these areas of the economy continue to represent a source of possible risk. We don’t expect much additional progress on the U.S./China trade front before the U.S. election, and business investment levels will likely remain muted as trade uncertainty continues.
As a result, we think stocks are likely to enter into a modest consolidation or correction phase in the near future, especially considering their strong rally over the past several months. Nonetheless, important factors like low bond yields, supportive central bank policy and improving economic growth are supporting equity prices. In the end, we think markets as a whole will likely generate only modest returns this year and near-term risks are elevated.
Top current themes:
- The December employment report was “good enough” for investors. While hiring slowed slightly, wage growth is not accelerating, which is good news for corporate profit margins. Additionally, a lack of strong wage growth would help keep inflation relatively muted, meaning the Federal Reserve has ample reason to remain on hold.
- Long-term jobs growth is slowing, but that shouldn’t mean the end of the current expansion. In 2018, average monthly jobs gains were 223,000.That slowed to 176,000 last year. But we think the interest rate cuts from 2019 are just starting to stimulate areas of the economy such as manufacturing.
- Inflation is a risk in 2020, but for now it appears absent. If anything, we see slight downward pressure on inflation right now coming from increased global competition and technological advancements.
- Rising tensions between the U.S. and Iran represent a possible risk, but markets have a history of looking past geopolitics. Politics and the year-end elections hold similar potential risk dynamics.
- U.S./China trade is unlikely to make much additional progress, but trade should be less of a risk in 2020. We see little chance of a phase-two trade agreement before the U.S. elections. But we expect less of a push for new tariffs and trade restrictions.
- This decade-long economic expansion has been very slow, and could continue. Since the financial crisis, households and businesses have approached spending and investing cautiously, which has caused a slow and prolonged expansion. Today, we are not seeing the imbalances that would suggest the expansion is ending.
- Corporate earnings could represent a risk in 2020. Stock prices have been rising for the last several months, even as corporate earnings expectations have been falling. In our view, expectations for 2020 may still be too high, which could put pressure on already expanded P/E multiples.
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