The past year will be remembered as a moment of reckoning for central banks. US stocks traded peacefully through a holiday-shortened Christmas Eve session, in contrast to the turmoil one year ago, holding on to gains that have made this the best year for equities since 2013.
2019 was the year where everything worked — stocks, bonds, gold, even bitcoin.
After the fantastic 2019 for financial markets, what does 2020 have in store for investors?
In order to answer this question, we need to examine the investment markets from a number of positions.
Current Situation – starting with the US
The major areas in focus for 2020 regarding US markets will be November’s presidential election, ongoing International trade & GeoPolitical tensions, and the Federal Reserve’s changes in monetary policy and forward guidance.
For the presidential election: 2020 is going to be all about politics. We think the markets are going to be a bit of a roller coaster based on what’s coming out in the polls particularly on the Democratic side. First of all, Elizabeth Warren or Bernie Sanders, Bernie’s unlikely, but, if Elizabeth Warren is the nominee that’s going to affect the markets or if it’s Mike Bloomberg or Pete Buttigieg, that has a different effect. We’re really going to have our head on a swivel for 2020, it’s all going to be politics, it’s going to consume everything.
As a result, we have a clouded political outlook in the US when you look at what could happen in the November 2020 elections. The election in the final quarter of 2020 is likely to be a major source of uncertainty. In our opinion, Low unemployment and trend economic growth favour Trump’s re-election. If the democrats did manage to gain even a small majority in the Senate, we see an increase in the corporate tax rate a likely outcome. In the event the democrats were successful, that full repeal would reduce S&P 500 earnings the following year by over 10% which would have a negative contagion effect in global stock markets.
For the Trade & GeoPolitical tensions: As we write, we have seen a massive heightening in International Geopolitical risks due to the US decision to assassinate the senior Iranian military leader. The full effect of this may take some time to assess and will be covered in separate notes in the coming weeks.
Separately we see an interim U.S.-China trade deal which would temporarily relieve trade concerns ahead of the U.S. presidential election and pave the way for a midyear, mini-boost in global growth led by U.S. rates and a weaker dollar. Currently, we have a situation where trade policy is muddled. And whether we get some sort of interim tentative deal to save the president’s election prospects, the reality is that China and the US are locked into a prolonged economic war. That creates its own level of uncertainty.
We are very bullish on gold due to both the heightened GeoPolitical risk and what the trend in interest rates is likely to be. We had this incredible statistic just a month ago where $17 trillion or a third of the global bond markets carried a negative yield. We don’t expect that condition is going to change.
Gold has this phenomenal inverse correlation to the general level of interest rates, especially real interest rates. So, we think that gold is going to continue to benefit from this bond yield landscape that we think is semi-permanent. We don’t believe this is going away any time soon.
Some analysts would suggest that gold is also valued by the equation, 1/T where T=trust. In the current economic climate, there’s just not a lot of trust right now when it comes to overall policy or geopolitics. So, we believe we are at the beginning of secular bull market in gold.
We think the move that occurred so far, depending upon whether you think if from $1,200 to $1,500 is just a minor blip, is the beginning of a move which could be several times higher in magnitude. And we think that, given how we measure the previous bull markets in gold and where we are in the cycle, we would be surprised to find gold below $3,000 five years from now. So, we think that it’s a very high-positive-expectation asset right now.
The theme for 2020 is really is about elevated, if not unprecedented levels of trade and policy uncertainty that has frozen business capital spending across the planet in 2019.
So, we have elevated levels of uncertainty. It’s caused this massive pullback in capital spending. It is estimated that business spending globally on a median basis is negative 5% at an annual rate year-to-date.
And that is really what is providing knock-on effects in terms of global economic activity. And of course, at a time when global supply chains are in retreat and global trade and investment flows are contracting for the first time in a decade.
We think that the temptation is to look at the stock market hitting all-time highs and to look at the latest round of GDP data and conclude that all is going to be well on this side of the planet.
We are not so sure about that, as we see countries like Germany, the UK, and Italy – three of the top four economies in Europe teetering on the brink of economic recession. Dramatic slowing taking place in China, and other parts of Asia clearly are slowing down.
When you get a situation where a hot spot like India now has auto sales domestically down more than 41% year-over-year in August and that until recently was the strongest component of global GDP, you know things are cooling off and cooling off dramatically.
In addition, we believe we are in a profit’s recession. Although nobody seems to talk about it very much. And yet the stock market as a whole is hitting new all-time highs.
Looking at the sectors we recommended in 2019, they have performed very well namely: telecom, services, utilities, real estate. These sectors are up c.26% year-to-date over the past 12 months. These are defensive rate-sensitive sectors and they performed as expected with a rally back towards the highs.
As investors, we must always have a theme. There are parts of the market we are bullish on. Certainly, we’ve been bullish on bonds. But in terms of the thematic in the equity market, because there is always a theme, we don’t have to buy the entire market and we don’t advise simply buying index equity ETFs. Currently we have a scarcity of value on our hands. We believe in owning what’s scarce globally. And what is scarce globally is yield and what is scarce globally is economic activity. So, you want to own income, because it’s scarce. And you want to own growth, because it’s scarce.
In addition, being long utilities and being long the areas of technology that have growth characteristics are very good places to be. Many of the cyclicals that have lagged, we would tip our hat to the growth stocks, companies like Microsoft as an example
On top of that, we think that what’s obvious is that central banks globally are in easing mode. The Fed is not done. And that’s going to continue to anchor interest rates across the yield curve at very low levels.
As a result, we think that the rate sensitives, as expensive as they are, will continue to be places of refuge in a troubled, global economic backdrop.
US Treasuries: If we look at the US bond market, the 10-year Treasury note yield peaked at around 3.3% in November of last year and fell almost in a straight line to 1.429%. Nothing in the markets moves in a straight line. We almost retested the post-Brexit July 2016 lows on the 10-year note (1.35% or 1.36%) at a time when the cost of overnight funds was materially higher.
We think that by the time the cycle is over, the funds rate will be back towards the zero-bound. And we believe that the 10-year note will be gravitating towards where the 10-year UK gilt is currently, 0.85%. There’s an incredible correlation between the gilt market and the Treasury market.
We find it hard to believe that gilt yields in the current backdrop are going to move up towards where yields are in the US. We think that US yields will move down towards where they are in the UK. We are not focused on negative yields in France or Germany or Japan.
It is quite possible that we could see a large influx into the US dollars, and into Treasuries particularly. And it could conceivably go down to those sorts of levels that people thought were impossible. But the more you look around the world, the more you realize that the impossible has not only become the possible, it’s become the probable. And that’s a material shift for people to try and understand what to do about that.
We don’t see the Treasury market losing the bid any time soon, even though we know that a lot of the holders are very nervous because we are in these strange uncharted waters. In our opinion, we’re not going to get to negative interest rates in the United States. And we don’t need that in our forecast to tell people that US bond market is going to be a very good place to be from a total return perspective.
So, why are interest rates so low?
If we step way back out to the big picture, the 30-year bond recently made an all-time new low, in all recorded financial history. By some accounts, we’re at a 5,000-year low in interest rates. That could be a pretty ominous sign of where we really stand economically.
This can largely be attributed towards demographics and technology and other secular forces; in particular excessive debt loads around the world. These sorts of secular structural forces have prevented inflation from coming back, despite all the efforts by all the fiscal policy makers and monetary officials.
Many people argue the decline in yields this year has to do with aggressive pension fund rebalancing or the machinations and incursions of central banks. We do not believe that’s the reason for the decline this year.
Yes, you could say that’s one of the reasons why yields are low i.e. you can point to all the aggressive movements to add assets and bonds to central bank balance sheets. But, that said, the Fed has been out of the Quantitative Easing (QE) game for years. The ECB, up until the September meeting, was out of it for months. The UK hasn’t been involved in QE for a long time. So, it’s nothing about Central Banks.
What happened this year in 2019 is a collapse in business investment globally for a variety of reasons. And interest rates, ultimately, equilibrate two very powerful curves namely investment and savings. Particularly, this year we had a collapse in capital spending from the business sector and a massive growth in savings. This isn’t just about excess global savings coming out of China. This is about a deficiency of capital investment globally.
The story is excess savings over investment. Or, alternatively, deficient investment relative to savings and that is the only possible academic explanation as to why bond yields melted as much as they did in the past 12 months.
The Fed & Modern Monetary Theory (MMT):
So, is there a solution? Globally we’ve cut rates. We’ve done QE. We’ve done Operation Twist. We’ve come up with every scheme imaginable and it still hasn’t worked. And so maybe it’s time to just print money. And maybe it’s time for MMT.
In our view, it’s just symptomatic of the problem here, which is, again, too much debt in the world. We’re once again going to try to cure too much debt with more debt. We’re going to come up with a way to justify it. We’re going to come up with a way to explain it. It’s a horse of a different colour. There is a day of reckoning that is due.
The Fed are confident about the outlook and especially in standing pat on rates, allowing them eventually to reach their inflation target in a persistent manner. We think they are wrong because the economy reacts to the change in financial conditions, not its level. Therefore, inflation and inflation expectations will continue disappointing, growth will relapse, and they will cut again in 2020.
The signal will, we expect, be the US curve re-inverting, global equities just starting to struggle to make new highs, and probably renewed dollar strengths (at least versus EM and commodities).
The one thing with inflation is that it is important to distinguish between domestically driven forces and global forces. So, we are obviously going to be talking the US here because it’s the most interesting inflation picture, where a lot of investors still believe that it will pick up eventually.
So, in the US, underlying domestic inflation pressures, which are best measured via services inflation (excluding energy and shelter), have remained very tame. You can see that core services inflation is picking up slowly but still fails to match anywhere close to what prevailed at full employment in the past two cycles. Even in this cycle, we are still far from the 3% line which was achieved in 2016. We’ve had new CPI data recently which basically showed that core goods are now at zero on the year-on-year basis. And we think we’re going to go back to deflation in 2020 unless we see a weakening in the US dollar.
It is also our view the Fed really wants to see the dollar depreciate. Why? Because that’s how you can increase inflation expectations and at the end of the day, if they’re trying to loosen monetary conditions, they don’t have to do that with actual policy. They can do that with the greenback, or at least by talking down the greenback. This is starting to play out, we think you will start seeing some weakening in the dollar.
We think that’s probably going to continue, especially given that Powell said that the Fed is likely going to just wait for persistent inflation. We don’t know when there’s ever really been persistent inflation in the eyes of the Fed, maybe pre-Volcker, but we think the theme is starting to play out.
You’re starting to see that in certain areas of the marketplace. Notably, financials, which have broken out relative to the S&P, those are starting to outperform, you would expect that if the yield curve is going to steepen, if you’re going to have a reflationary behaviour, that financials would benefit and probably be the next leader in the next cycle.
It’s hard to see how you’re going to have a meaningful bear market or recession with over $250 trillion of global debt, the US accounting for 60% of the increase this year. We believe the old school of thought, which is we must inflate our way out of this debt is probably going to be the overarching theme for the next few years.
We think that this is not just a US phenomenon. We know that all Central banks now are looking to try to find ways to reflate and inflate, they’ve failed so far to any meaningful degree, largely because in their efforts to inflate, they’ve actually encouraged more debt, which is the paradox that all Central Banks are faced with. That doesn’t mean they’re going to stop trying, though. Unfortunately, the definition of insanity is doing the same thing over and over again and Central Banks are very good at doing the same thing over and over again.
We are still expecting the yield curve to steepen. In reality, that steepening is just based on the Fed catching up to our view. They’re the last one to figure it out. Once they do, they steepen the curve by cutting the short end out and we think that if they don’t do that, then they perpetuate having to do more when they finally do that. They are the catalysts for their own panic if they don’t acknowledge it soon enough
We wonder if we’re going to see a reversal of that recessionary fear trade, which you don’t see in the S&P, but you do see it in the bond market. If that reversal comes true, you’re going to see a reallocation of bonds to some extent into equities. However, there are still risks. This is not a secular bullish reflationary argument because we do think that there’s a difference between the hope for reflation and then the actual reality of reflation. If you’re going to have this feeling of recession is not coming, we still have a few years left, forget about the election, the bull market does continue. You get a trade deal. All these things could be positive catalysts, and we think could cause a lot of money to move into beaten down areas, notably small caps, which have not reached new highs.
We think you’re going to see commodities really start to run, too. Commodities against the S&P are at historic lows. That is one trade, which we think could come out of nowhere. If that happens, you get cost push inflation, yield curve steepening because commodity prices are rising, emerging markets moving, it’s all one consistent thesis
Emerging Markets (EM)
In emerging markets, the official political calendar is relatively empty in 2020. The most important issue remains to be international trade tensions and developments. In the 10 months running up to the US election, we do not expect to see any big trade shocks, and as a result we see EM Asian economies stabilising this coming year. We also forecast that overall EM inflation will remain low and EM central banks will follow in the footsteps of the fed: leaving rates low and some even easing further next year. In summary, we see emerging markets experiencing growth in 2020 and have shifted our view from last year to now be moderately overweight EM risk-on assets. We see room for many EM central banks to ease, supporting EM growth. This underpins our overweight’s in EM debt, particularly local-currency, and in high yield.
Weaker dollar: Furthermore, we expect a weaker dollar next year which will add value to our EM positions. Many emerging markets issue considerable amounts of debt denominated in US dollars. Dollar weakness pushes down the cost of this debt. The corresponding strength of emerging market currencies makes it cheaper for emerging countries to buy the US dollars they need to meet bond repayments.
China: While China’s economic growth may dip below 6% due to cyclical and structural factors, monetary and fiscal easing over the past 18 months should allow it to stabilize. Future massive monetary easing or infrastructure spending is unlikely, given China’s focus on sustainable growth. Instead, growth will be anchored by the consumer: the rise of China’s middle class should continue to fuel demand for consumer goods and services.
Elsewhere: In Latin America, domestic policy remains, as usual, a key variable. Both Brazil and Mexico should see a significant pickup in growth compared to 2019, offsetting a continued recession in Argentina, and allowing the region to expand more strongly in 2020. In parts of the emerging world, near-term rate cuts remain likely. In particular, we see further sizable moves in Turkey, Russia, Mexico, Brazil, South Africa, and Egypt on the back of below-potential growth and subdued inflation.
S&P500 earnings per share are forecast to grow 8 percent to $177 at year-end, and returns will likely be driven solely by corporate earnings vs. price-to-earnings multiple expansions. Emerging markets could offer more upside in 2020: crowded positioning in the U.S. vs. the rest of the world, and estimate revisions abroad outpacing those in the U.S. support a rotation into global equities.
What about Europe
Overall, we are looking for a gradual pick-up in growth across the Eurozone during 2020. The absence of inflation pressure means the ECB is unlikely to consider lifting interest rates. In September 2019, the ECB introduced a brand-new open-ended asset purchasing program where they will spend €20 billion per month for as long as it takes, until they are ready to start raising interest rates again. This should continue to support the economy as a whole, supplying a constant injection of readily available cash into the system.
The easing of political risk is also a boost to the outlook. One year ago, Italian 10-year sovereign bond yields were heading toward 4% and creating concerns about the solvency of Italian banks. These yields are now at 1.4%, mirroring declines across Southern Europe and supporting financial conditions. This is being reflected in declining non-performing bank loans across Spain and Italy. The recent lifting of short-term Brexit uncertainty is also a boost to Europe, Boris Johnson is now expected to officially take the UK out of the bloc before the end of January 2020. However, the next stages of Brexit could prove to be tricky, the focus for 2020 will be on securing a trade deal between the two unions.
We have started to see early signs of stabilization in the manufacturing sector, which is twice as large relative to GDP in Germany as in the US. In addition, we also expect a moderate fiscal boost of about 0.3% in the Euro area, mostly because Germany is—belatedly and incrementally— moving toward a more expansionary setting. All told, we expect the sequential annualized pace of Euro area growth to move up from the current 0.2% to just over 1% in 2020—only a little above trend but probably enough to keep the labour market recovery going in most countries.
Germany, with plenty of capacity to spend and near record low bond yields, seems an obvious candidate for fiscal stimulus. But at present the government seems unwilling to loosen the purse strings. This is largely because unemployment is so low and economic conditions, in the ruling coalition’s eyes, do not seem dire enough to warrant breaching their self-imposed fiscal discipline.
And then there’s Britain….
After the Conservatives’ strong victory in December’s general election, and a majority secured within parliament, the UK is now set to leave the European Union by the end of January 2020 with Johnson’s Withdrawal Agreement that he struck back in October. This will lead us to the next phase of Brexit: negotiating a trade deal over the course of the next 12 months. The UK will now enter a transition period that is scheduled to end on December 31st, 2020. During this time the UK will effectively remain in the EU’s customs union and single market, but there will no longer be any British members of the European parliament.
Sterling has received a boost after the December 2019 election result, based on near-term certainty with Johnson being granted license to push his Withdrawal Agreement through parliament in January 2020. However, we expect this surge to be contained as the UK enters a new and very challenging phase of negotiations regarding its future trading relationship with the EU, which will be the main theme when it comes to Brexit in 2020. We are expecting a short-term rally if Johnson’s deal does indeed pass through parliament, but we will then essentially be entering the unknown, we see little room for a rally beyond $1.40. In addition, we feel that the recent election has distracted market attention from an increasingly worrisome economic outlook in the UK with many recessionary warning signals flashing. Johnson will now publish Brexit legislation before the end of 2019 that will prohibit him from extending the standstill transition period covering relations with Brussels beyond December next year. That potentially would create a cliff-edge scenario at the end of 2020 if no deal is in place. In the event of very little progress being made, we see a huge area of focus in the second half of 2020 to be the market worrying about, and partially pricing in, a ‘no-trade deal Brexit’. This would be negative for UK equities and GBP, keeping the BOE in limbo while it waits for clarity.
In the event of increased likelihood of a UK-EU trade deal at some stage during 2020 and/or fiscal stimulus, we expect the UK economy to be supported. A significant boost from fiscal policy is likely, which would reverse a decade of deficit-reducing “austerity”. A post-election economic revival combined with low unemployment and relatively high inflation could have the Bank of England considering policy tightening by the end of 2020.
The UK appears as one of the most obvious candidates for fiscal stimulus. It has the capacity to give itself a significant shot in the economic arm, while the country’s politicians appear to have the will to do so. By contrast, most other leading political parties around the world seem less willing to be proactive.
Our view on currencies
We expect the US Dollar to weaken in 2020 as we see diminishing policy uncertainty. Volatility for major currency pairs has been very low in 2019 but we do see the euro and sterling benefitting from a resolution of Brexit uncertainty over the next year, with EUR/USD and GBP/USD rising from the 1.12 area to 1.15 and 1.31 to 1.39 respectively. Stronger global growth and a weaker dollar should help support emerging markets. Many commodities are priced in US dollars. A lower dollar will result in higher commodity prices, which is helpful to commodity producers and exporters, and can more broadly stimulate growth and inflation.
A weak dollar could indeed grease the wheels of global trade and by extension give the world a significant growth boost. Without US dollar weakness and a corresponding pickup in growth as outlined above, it seems probable that the global consumer, arguably the last bastion of economic demand, will slow their purchases. Companies will have to consider reducing their cost base, which means reductions to the workforce and rising unemployment.
Should such circumstances transpire, the Fed would cut interest rates and the last two sources of US dollar support, the US’s relatively high level of growth and interest rates would be no more. It therefore seems probable we are in the latter stages of the US dollar bull run. Given the richness of the US dollar as well, it seems reasonable to start positioning for a reversal.
We are forecasting modest commodity returns in 2020, with dispersion expected within energy, metals and agricultural. Brent crude could hit $70 per barrel by midyear, while diesel may near $100/bbl. Summer U.S. natural gas prices could fall below $2/million British thermal units, as forward balances continue to weaken after the winter. Cyclical raw materials should benefit from a potential inventory restocking cycle, easier Fed policy, and an interim China trade deal, providing an attractive inflation hedge. While copper and nickel are likely to rally in 2020, the outlook for gold and precious metals are bullish longer term.
So, what’s our overall position?
Coming into 2020, we expect to see higher economic volatility and political uncertainty which will be reflected in the financial markets. We continue to advise our clients to hold blue chip high dividend yielding stocks with low beta. Our preferred alternative assets include gold, agricultural commodities, alternative energy assets and infrastructural assets. We see the current outlook for interest rates as lower for longer, in our view the Fed will cut further this year, which makes many of these assets attractive in terms of yield over the medium to long term.
See our positioning for each asset class in 2020 below:
- We remain bullish on gold going into 2020 and expect to hold onto and even add to positions over the course of the year. If the Fed changes their narrative from current ‘pause-mode’ to further easing, then we will see another significant break higher in the precious metal, similar to that of summer 2019.
- We see stock markets, particularly in the US, continuing to grind through highs in H1. Focus will start to shift more towards the US election in H2, where we could see significant pullbacks should markets begin to price in a democrat victory.
- FOMC and global central banks will be forced to continue to ease despite the Fed’s plan for 2020 to hold rates where they are and wait-and-see. ECB will be stuck in their open-ended asset purchasing program, with markets potentially demanding even more than the current €20bn per month.
- As one of the only positive yielding of the main sovereign bonds, US treasury yields will likely continue to fall this year as yield becomes even more scarce. However, we do not see negative rates in the US at all in 2020.
- We feel the US dollar index (DXY) has put in or will put in a top early in the year. With equities, bonds, and the dollar strong in 2019, we feel that it is the dollar that ‘has it wrong’ so to speak. USD volatility is at the low end of its long term range, if it remains down here we expect the DXY to drop from current levels of 96.38 to 94.50, however if volatility significantly picks up we could see a more dramatic move in favour of the dollar due to an increase in demand for US treasuries which are deemed a safe-haven asset.
- The ECB will continue all year to inject money into the economy, this along with a gradual pickup in growth will support European markets. All eyes will be on any potential trade deal that the EU can strike with the UK this year, with this being the main source of uncertainty in H2.
- It is our expectation that emerging Markets will receive a boost in 2020 following easing from EM Central Banks, many of whom are playing catch-up to the Fed. A weaker dollar this year and a potential interim trade deal between China and the US before the US election will also support growth in these regions.
- Commodities should see a modest general bid especially if we get a turn down in the US dollar, we believe this will come in Q1. Agricultural products such as soybeans and corn will receive a sustained bid if we see an interim China-US trade deal. Commodities vs the S&P500 index are at historic lows, we see an opportunity here for even a slight closing of the massive gap during 2020.
Finally, we wish all our clients a very Happy and Prosperous New Year. If you would like to discuss anything raised above or would like a review of your financial position, please do not hesitate to contact us
Tel: +353 1 70 70 000
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