2020 Market & Economic Outlook

In short

• After four years of discord in Washington D.C., the 2020 elections are at hand – and could bring changes for the economy and policy.
• After deceleration stoked fears of a recession, the U.S. economy has stabilized, perhaps setting the stage for stronger global growth.
• Accommodative monetary policy should support continued gains in risk markets.

Elections

Elections globally tend to demand the focus of investors, as they represent a potential shift in policy, and reflect the sentiment of consumers – which here in the United States have driven GDP growth over the last decade. Over the past six years, a wave of populism has swept the developed world, and the election of President Trump was a result of a demand for a new type of political environment. Four years later, and little has changed as it relates to the base of support upon which the President built his successful campaign for the White House.

More broadly, the economy continues to grow at a modest pace, unemployment remains low, and inflation is still a non-factor. While immigration, health care, and taxes dominated the first half of the President’s term, the focus since early 2018 has been on trade policy – a key part of the 2016 platform – and it is this shift that has caused global investors the most consternation. The goodwill built up by the decrease in the U.S. corporate tax rate, and the expected growth in capital expenditure which was to follow, has been stymied by depressed CEO confidence against an uncertain backdrop for trade, despite a more supportive regulatory and tax environment.

In addition, while the equity markets continue to hit new highs, income inequality appears more pronounced, and skyrocketing costs for health care and college have come under attack by a cadre of Democratic hopefuls. Touting a more progressive agenda, paid for with increased taxes on high earners and (likely) corporations, the Democrats are hoping to engage Main Street in a similar manner to President Obama’s first Presidential campaign, which occurred during the deepening financial crisis.

For markets, the uncertainty of the outcome of the election is what is most critical. Political platforms are constructed in an attempt to win elections, and the ability of the executive branch to effect change can be limited – depending on the changes desired – within our political system. Moderation, or a move towards the middle, typically occurs as elections near. Therefore, it would not be surprising to see the equity market here in the U.S. ebb and flow along with the polls in the first half of the year; the pricing in of either of the above outcomes will not truly occur until late summer or early fall, and typically markets perform well post-election, as investors redeploy capital based on their expectations for the new leadership – especially if the economy is growing. Opportunities are often created based on this uncertainty, and therefore investors should remain focused on fundamentals, mindful of truly transformative policy changes that could impair businesses.

Economy

Recessions are inevitable. The U.S. economy has been in expansion for the longest period in history. Therefore, we must be on the precipice of a recession. This is the logic espoused by many in 2019, but to be fair, the view was not without merit. The manufacturing economy in the United States slipped into contractionary territory following the escalation of trade tensions with China. Confidence was slipping, and even the consumer seemed to lose some steam in early fall. Leading economic indicators, which are viewed as a barometer for the economy, decelerated and were buoyed by the performance of the S&P 500 index (which is one of the underlying factors for the measure). Wages seemed to stagnate, the yield curve inverted, and it was difficult to see the catalyst that could put the economy back on its (admittedly slow) growth track. Outside of the United States, the story was similar, with Brexit representing an overhang for the U.K. and Europe, and Japan still grappling with how to kickstart their economy after decades of deflationary pressure. Emerging markets, too, have struggled in this low growth environment, particularly for commodity producers who have experienced downward pressure on prices for the last decade.

However, over the past two months, economic data appears to have stabilized, and in some pockets, exhibited acceleration. The growth experienced in the U.S. given the massive tax stimulus is perhaps lower than expected, but it remains on trend for the last 4-5 years, and an engaged U.S. consumer is enough to keep this pace. In addition, modest acceleration of growth in Europe, China, and the U.K. could occur, particularly if Germany loosens its fiscal grip and enacts stimulus to catalyze the flagging manufacturing sector in their country, and a reasonably amicable Brexit deal is approved. The threat of recession in 2020 – once the prevailing consensus – seems very unlikely at this juncture, and this base case points to the opportunity for greater gains in risk assets in 2020.

Easing

Perhaps the greatest driver of our constructive view on risk markets, particularly equities, for this year is global central bank policy. The about face by the Fed to close out 2018 and clear indications by the Bank of Japan, European Central Bank, and Bank of England that loose monetary policy will exist for the foreseeable future have kept a lid on sovereign bond yields and driven investors to allocate capital to equities and credit. As such, we expect equities to continue to appreciate in 2020, despite valuations that appear somewhat stretched, at least in the U.S. after 2019’s gains. We believe that the gains in U.S. stocks will be driven by a positive lagged effect of the Fed’s rate cuts last year, as well as a potential trend change exhibited by a reallocation of funds from defensive sectors, which have led the market over the last 19 months, to more cyclical names in areas like industrials, financials, materials, and consumer discretionary. In addition, should trade tensions continue to ease following the most recent agreement between the U.S. and China, and global growth inflect higher, international and emerging markets equities could post returns even better than the U.S. - particularly if the U.S. dollar remains stable. As for the bond markets, yields remain historically low, and therefore relatively better returns in corporate credit could continue as investors hunt for reasonable income. For taxable investors in the U.S., municipal bond prices remain supported by strong demand unmet by supply, particularly in high tax jurisdictions.