In 2019, falling interest rates, low inflation and accommodative central bank policy rewarded investors with robust returns across all asset classes. These factors helped markets withstand increasing uncertainty around trade, geopolitics and the stability of the aging bull market. Global equity markets delivered double-digit returns, U.S. equities reached record highs, and fixed income and diversifiers posted solid returns in the mid-to-high single digits.
As we look ahead to 2020, we expect a modest improvement in global economic growth given signs of stabilization in global manufacturing, synchronous central bank easing and a de-escalation of trade tensions. Returns are likely to be dispersed across asset classes in the year ahead and uncertainty will persist, especially in light of ongoing geopolitical issues and the impending 2020 U.S. presidential election. For investors looking to grow their portfolio and protect against volatility, an active approach will be critical in the year ahead.
Slow Global Growth, No Sign of a U.S. Recession
In 2020, we expect real global gross domestic product (GDP) to come in around 3%. In the U.S., growth will likely outpace the trend growth of roughly 2% in 2019.
As illustrated in Exhibits 1 and 2, high consumer confidence and spending has buoyed the U.S. economy even as manufacturing, business investment and CEO confidence have retreated amid the uncertainty around trade. We expect the consumer — who accounts for 70% of the U.S. economy — to continue spending and supporting economic growth into 2020. However, an improvement in CEO confidence, and the resulting increase in business investment that would likely follow, will be necessary to keep the current economic expansion on a stable footing.
In Canada, most experts are predicting real GDP growth of between 1.5% and 2%, while we expect the Eurozone to continue to struggle in 2020 with growth dependent on the degree to which trade deals and Brexit help revive manufacturing and business investment. Annual real GDP growth for 2020 is likely to be near the projected GDP for 2019, 1.2%. In China, growth is expected to remain moderate, below 6%, and we expect further monetary and fiscal easing in an effort to offset the slowdown resulting from tariffs.
Central banks continue to be accommodative with the Bank of Canada, the U.S. Federal Reserve (Fed), the Bank of England, the European Central Bank (ECB) and the Bank of Japan (BOJ) keeping rates low (or negative, in the cases of the ECB and BOJ) in order to stimulate growth. With inflation expectations still materially lower than its 2% target, the Fed should remain on hold in 2020. While there is a possibility of one insurance cut before June, the Fed typically does not make monetary policy changes during election years. Similarly, the Bank of Canada has been reluctant to lower interest rates, however the extent to which global trade conflicts weigh on global economic activity may ultimately impact their decision.
Muted Fixed Income Returns
Our base case for slow growth and no U.S. recession drives our expectation for the shape of the U.S. Treasury yield curve. The short end of the curve should stay low, or move modestly lower, for many quarters ahead given the unlikelihood of a change in posture from the Fed. However, intermediate- and long-term rates will most likely drift higher, resulting in a modestly steeper yield curve.
Our projection for the 10-year Treasury note yield range during 2020 is 1.25% to 2.50%, likely ending 2020 close to 2.25%. There is a limit to how high long-term U.S. rates can go as they remain tethered to low global rates. While we do not expect the extreme interest rate volatility we saw in 2019 — where the U.S. 10-year yield moved from a high of 3.11% to a low of 1.44% — we could see some volatility in either direction. The uncertainty around the pace of growth, geopolitical concerns or the outcome of the U.S. presidential election could be the source of interest rate volatility. In Canada, while 10-year yields are currently 0.2% to 0.3% lower than the U.S., Canadian long-term yields are typically highly correlated with those south of the border and are likely to follow a similar trend moving forward.
Given that rates are currently quite low and credit spreads are tight, we expect fixed income returns to be more muted in 2020. Credit fundamentals are still solid with corporate bonds benefiting from decent earnings and a moderate level of defaults. However, given the significant growth of corporate indebtedness, investors are not getting paid to take a lot of risk in credit markets. High-yield corporate bond fundamentals also remain solid with default rates low; however, these bonds can become more volatile as the cycle matures and the probability of recession increases. While this is not our base case, there is the potential for volatility in spreads as well.
Earnings Drive Modest Equity Returns
U.S. corporate profit growth was weak in 2019. The impact of the U.S. 2018 tax cuts created a challenging comparison for year-over-year growth, and slowing demand and trade uncertainty weighed on profits. We should see profits rebound over this low hurdle in 2020, given our forecast for approximately 2% GDP growth and modest inflationary pressures.
We expect S&P 500 companies to deliver a year-over-year earnings growth rate of 4-6%, which should translate into an operating earnings range of between $165 and $175. From this, we also project an S&P 500 year-end target of between 3,300 and 3,400. Earnings growth outside the U.S. is also expected to improve. Bloomberg consensus estimates of year-over-year earnings growth are over 7% for developed international equities and 14% for emerging market equities based on a stabilization in growth, and some clarity on the direction of trade and Brexit helping to encourage business investment.
Balanced Positioning Allows for Potential Shifts
Overall, we maintain a relatively favorable outlook on the macroeconomic backdrop. We continue to favor global equities over Canadian equities, while maintaining our neutral view on equities overall. We have been adjusting our mix of equities over the course of the last 18 months to this more neutral posture. Given the prospect of increased volatility resulting from ongoing trade disputes, Brexit and the 2020 U.S. presidential election, we believe this positioning provides us the flexibility to make potential shifts depending on the impact that events, policy decisions or economic data may have on our forecast.
We have a small underweight to fixed income, but expect it to continue to play an important role as a source of diversification during periods of equity market volatility.
We also have a slight overweight to diversifiers to buffer against the expected volatility. Private equity and real estate can provide attractive sources of return.
Be Active With Your Wealth
At this late stage of the bull market, with valuations of many asset classes near or above their long-term averages, the need for active management — from both a portfolio positioning and a security selection standpoint — is more important than ever. After a year where the market has lifted all asset classes, it's important to ensure that portfolios remain aligned to the allocation that reflects our current best thinking and conform to the appropriate level of risk tolerance. We also highlight the importance of after-tax returns and work with clients to harvest losses to help minimize taxes where appropriate.
While the current bull market may not end in 2020, it will end eventually. Though the backdrop of low inflation, strong labor markets and ample liquidity provided by central banks has helped to extend the now more than 10-year-old business cycle, clients should continue to focus on their long-term investment plan and ensure it reflects their future goals, their current needs and their ultimate desire for what they want to accomplish with their wealth.