Clearing macro clouds provide 2020 vision for equities
To get some perspective for the 2020 investment outlook, it is worth reviewing how markets fared in 2019 and over the past decade. Global equities (including dividends) returned 27% in 2019, the best performance since 2009 and almost all regional markets have made gains – see the market highlights page opposite. Markets were driven higher, as central banks cut interest rates to kick-start the economic recovery in the last few months of the year. This accommodative policy more than offset the drag from tit-for-tat US-China trade tariffs, which led to slower company earnings growth over the course of 2019. On a longer-term horizon, the US equity bull market is now into a record 10th year and has outperformed all other major stock markets and assets classes. That raises the bar for US stocks to continue to outperform on a relative basis.
Looking forward to 2020, we see clearing macro clouds, with an outline US-China trade agreement now possible. It probably doesn’t make sense for President Trump to escalate the US-China trade spat to hinder output/jobs growth and risk his re-election bid. Moreover, globally, monetary and fiscal policy is increasingly being used to support economic growth. Our base-case scenario of faster global growth in 2020 increases the probability that companies can deliver on earnings expectations. Not only should this raise risk appetite, but it also adds clarity on the market outlook.
Given that the US has not experienced a recession in 2010-2019 (the first time the economy didn’t contract at some point in a single decade since the data began in 1850), tail-risk late cycle vulnerabilities persist. Nevertheless, US recession risk has been mitigated by what looks like a recovery in the manufacturing sector, healthy non-farm payrolls and stronger consumer confidence that continue to provide uplift for the US (and thus the global) economy.
Rising opportunities for non-US equities
If the global business cycle is to be extended (our base case scenario), we see better investment opportunities outside of the US. This view is broadly predicated on the rest of the world catching up with the growth rate of the US. The IMF forecasts that nominal GDP in Advanced Economies ex-US will expand +0.1% point faster than the US in the years 2020-2024, a stark contrast to a -1.7% growth deficit against the States in the previous decade. Translating this macro backdrop into company earnings, the consensus forecasts that World ex-US 2020 Earnings Per Share (EPS) growth at 10.3% versus 9.4% for the US. Consequently, faster relative earnings growth should favour non-US equities. Moreover, US-centred risks have grown, with valuation headwinds from the tech sector, which trades on 7.7 times its book value (the highest level since the tech boom in 2000) and accounts for nearly a quarter of market cap. Tech stocks may also face potential break-up risk and greater regulation over data privacy should a progressive left Democratic candidate win the presidency in November 2020.
Out of non-US markets, the UK is perhaps the standout opportunity for 2020. Following an election that delivered a Tory majority government, the political risk of a left-wing Labour government has likely been averted for the next 5 years. The government will now be free to concentrate on “Borisnomics” (see our September 2019 Investment Outlook) of low tax rates and deregulation to provide a business-friendly environment for companies to operate. Over time, we expect current cheap UK equity valuations (and particularly domestically focused stocks) to mean revert and drive up equity prices in the process. Though the government has introduced legislation that prohibits an extension to the transition period beyond 2020, we believe the risk of a “no deal” Brexit deal with the EU is probably contained. That’s largely because; i) it is in the interest of both the EU and UK negotiators to work out an economically beneficial Canada-style Free Trade Agreement (FTA); ii) PM Johnson has a sizeable majority in the House enabling him leeway to agree terms of any potential FTA; and iii) after being part of the EU for over 40 years, the UK is already aligned to EU regulations and product standards, which should make negotiations easier than for a non-EU country.
The Eurozone is another equity market that looks increasingly attractive. Lead indictors of growth, such as money supply, point to upside in economic activity. Given that European equity funds have seen heavy net outflows worth 12% of assets under management since the start of 2018, even a modest increase in the region’s growth prospects should improve the market outlook. Finally, after lagging global markets in 2019, Emerging Markets (EM) at current undemanding valuations are an opportunity for investors. EMs typically perform in the up-phase of a global recovery cycle. Fundamentally, the consensus forecasts EM EPS growth of 15% in 2020, the highest out of all the major regions, backed by growthfriendly policy support from China (see our December Investment Outlook). A key risk for EMs is the direction of the US dollar, which has typically depressed relative performance, but with the Fed easing monetary policy, the risk of Greenback upside seems contained to us.