2019 will be remembered as a year in which it was very difficult to lose money. All major asset classes outperformed their 10-year average returns during that wonderful calendar year, which shows just how unusual a year it was. While we believe 2020 will also deliver positive returns for global risk assets, investors should expect more moderate returns compared to last year.
Central to our outlook is our belief that global growth will be modest and that the U.S. will not experience a recession. We expect the recent recovery in economic momentum will extend the long global expansion and that U.S. real gross domestic product (GDP) will come in around 2%, although if we see continued progress on trade and business investment this estimate may be a bit too conservative. Global real GDP is estimated to deliver around 3%. Let's take a deeper look at six themes that will help shape the market and our investment positioning in the slow growth environment of 2020.
Accommodative Global Monetary Policy
In 2019, central banks globally shifted to easier monetary policy — a trend we believe will persist through 2020. We expect the Federal Reserve will remain on hold in 2020 amid an environment of slow, but positive, growth and moderate inflation. While there is the possibility of a midyear cut if economic softness or trade tensions have a negative impact on the Fed's global growth forecast, the central bank historically stays on hold during an election year.
Global central banks have also been accommodative. Whether it be the People's Bank of China's reduction of banks' required reserves, the Bank of Japan's approval of a new fiscal package, the Bank of Canada's commitment to keep rates low, or the European Central Bank and Bank of England's accomodative posture, these central banks are committed to stimulating global growth and achieving price stability.
Trade Tensions Persist
The signing of a "phase one" deal between the U.S. and China in mid-January has certainly helped de-escalate tensions and improve investor and market sentiment. While the deal included many positives — including China's agreement to purchase $200 billion worth of U.S. goods and services, intellectual property protections, an end to forced technology transfer of U.S. technology to Chinese companies and access to the Chinese market for financial services — enforcement around these key provisions will be critical. Keeping many of the existing tariffs in place provides an enforcement mechanism and lever for future negotiations.
Despite the phase one deal, we continue to believe that trade is likely to be a long-standing issue between the U.S. and China. While we would like to see corporations return to spending on capital improvements, many supply chains have already been permanently disrupted and business investment will take time to return.
Since the stock market doesn't have much practice in properly pricing trade wars, trade headlines (either positive or negative) should continue to cause markets to behave in either a pessimistic or euphoric manner as they attempt to price in the latest new information. Both countries have agreed to begin discussions on a "phase two" plan, which is set to focus on structural issues of the Chinese economy — state owned enterprises, subsides and the lack of a market mechanism — but investors should be prepared for bouts of heightened volatility for the foreseeable future.
Volatility is a part of investing and a theme we've carried over from prior years. Despite all of the headwinds of trade, recession fears, Brexit and an inverted yield curve, last year was less volatile than average. In light of the late stage of this bull market, as well as the potential geopolitical conflicts and political uncertainties that still exist, we expect equity market volatility to return to more normal levels in 2020.
Low Inflation and Interest Rates
Our view of modest global growth and no U.S. recession is based on our belief that both inflation and interest rates will remain low throughout 2020. A "lower-for-longer" theme has been in our vocabulary for the better part of 2019, and we see that continuing this year.
While domestic rates will be tethered to low global rates, the Treasury yield curve is expected to steepen again. Short-term rates should remain anchored by the Fed, while long-term rates may move only modestly higher on improved economic data and moderate inflation expectations. The U.S. Treasury 10-year note yield will likely range between 1.25% and 2.5% for 2020, ending the year near 2.25%. This theme of lower inflation and interest rates should allow central bankers around the world to maintain their accommodative policies, and thus provide a positive backdrop for most asset classes in 2020.
Earnings-Driven Moderate Equity Gains
Stocks delivered strong returns in 2019, driven entirely by price-to-earnings (P/E) multiple expansion. Given our expectation for economic growth to improve slightly, we believe the S&P 500 will deliver mid-single-digit earnings growth. Combined with a 2% dividend, this would suggest modest equity returns as we expect little in the way of price/earnings expansion.
History shows high P/E expansion years (such as 2019) are followed by years with modest equity gains. While global equity valuations are in line with or above their long-term averages, we continue to view equities as fairly valued, especially when taking into account levels of inflation and interest rates. As such, we would expect any pullbacks to be mild, perhaps offering investors an opportunity to add equity exposure if they are underweight.
Geopolitical Uncertainty Intensifies
Although some of the uncertainty around trade and Brexit eased at the end of last year, geopolitics will certainly be present in 2020, exacerbating volatility. Being bombarded with 24/7 news reporting can further exaggerate the volatile impact daily headlines can have on asset prices. The recent conflict between the U.S. and Iran illustrates the impact geopolitical events can have on markets around the world. Other events, such as the U.S. presidential election and Brexit, are known in the market but can also deliver a bout of market volatility, especially if the ultimate outcome is a surprise. While events such as these can drive short-term price action and even investor sentiment, it is best for investors not to lose sight of the long-term benefits of staying invested, as markets have a history of eventually refocusing on fundamentals such as earnings, inflation and interest rates to determine their ultimate value.
History suggests that years of strong market performance are often followed by good years. We believe that will be the case in 2020, but expect returns across asset classes to be more moderate.
We are generally optimistic about the backdrop of slow growth, supportive central banks and contained inflation, which should allow equities to appreciate further. However, given the higher volatility we expect throughout the year, we believe that a balanced, diversified portfolio should suit investors best as we march through 2020.