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Investment outlook

10 predictions for 2020: Midyear update

Robert (Bob) C. Doll
Senior Portfolio Manager & Chief Equity Strategist
Ten predictions - large 10 over blue background

Improving conditions but growing risks

In January, we offered our usual annual set of 10 Predictions that were based on our premise that the economic expansion was getting long in the tooth but still had some life left. The coronavirus pandemic changed everything. Amid the height of a new bear market and sharp recession in April, we recast our predictions to provide investors with some new perspective about where things might be heading. We’re going to continue keeping track of (and scoring) both our original and newer predictions through the rest of 2020. At this point, we think conditions will continue improving, but we are also growing more concerned about rising market risks.

10 Predictions


A light at the end of a very long tunnel

At the start of the year, we expected economic growth to pick up modestly, and were encouraged by seemingly diminishing macro risks, such as trade policy. Conversely, we were concerned by relatively full stock valuations, and thought that market gains could be limited following a strong 2019. The unanticipated coronavirus pandemic and resulting economic and market upheaval threw all of this for a loop. The (mostly) new predictions we offered in April were predicated on our expectation that the crisis would peak in the second quarter, paving the way for a slow economic recovery in the second half of the year. Below, we offer scoring and commentary on our full list of predictions.

1. Original: The world avoids recession in 2020 as U.S. GDP grows over 2% and global GDP grows over 3%.
Scorecard for heading in the wrong direction

Update: The U.S. and world experience a sharp, but reasonably short recession with noticeable recovery before year-end.
Scorecard for heading in the right direction We didn’t quite get to the twelfth year of the expansion as the outright halt in economic activity pushed the world into a sharp and deep recession. But, so far the evidence suggests that while this will be the deepest recession in post-World War II history, it will also prove to be the shortest.

2. Original: Inflation and the 10-year U.S. Treasury yield end the year above 2% as the Fed stays on hold through the election.
Scorecard for heading in the wrong direction

Update: All-time low yields move higher during the second half, with the 10-year Treasury closing the year above 1%.
Scorecard for too early to call
The yield on the 10-year Treasury plummeted to record lows amid the heart of the crisis in March, and has since been moving in fits and starts. The yield did get close to 0.9% earlier in the second quarter before falling again and ending the quarter just below 0.7%.1 As economic growth starts to improve, and as investors move back into risk assets, we think bond yields will rise modestly. An increase in the 10-year yield to over 1% would be a sign that the economy is reaccelerating.

The recession has already ended, but we may not get back to expansion mode until late 2021 or 2022.”



3. Original: Earnings fall short of expectations, partially due to rising wage rates.
Scorecard for heading in the right direction

Update: Earnings collapse, but rise smartly by the fourth quarter.
Scorecard for too early to call
Going into 2020, we thought earnings expectations for 2020 were too high. Expectations have since collapsed, although obviously not for the original reasons we anticipated. At the start of the year, the bottom-up consensus for S&P 500 earnings per share was $177, but has since dropped to $124.2 Although second quarter earnings results are going to be abysmal, we expect a recovery by the end of the year.

4. Stocks, bonds and cash all return less than 5% for only the fourth time in 25 years.
Scorecard for too early to call
This is one of the three predictions we left unchanged. Markets experienced this phenomenon in 2005, 2015 and 2018.1 At the mid-point of 2020, stocks have performed better than we would have expected three months ago, but are still in negative territory for the year. With the Fed anchoring short-term rates at zero, cash returns have been miniscule. Bonds are ahead of where we thought they would be (The Bloomberg Barclays U.S. Aggregate Bond Index is up 6.1%),1 but that could change if longer-term yields rise.

5. Original: Non-U.S. stocks outpace U.S. stocks as the dollar retreats.
Scorecard for heading in the wrong direction

Update: The dollar weakens as global growth strengthens in the second half.
Scorecard for heading in the right direction
This prediction was originally based on our view that the U.S. dollar would fall and that non-U.S. stocks offered better relative valuations. During the crisis, however, non-U.S. stocks have been hit even harder than their U.S. counterparts and have not recovered as quickly. The value of the dollar fell during the second quarter and is basically flat for the year. We expect improving global growth will put downward pressure on the dollar in the second half of this year. Massive U.S. deficits will also act as a drag.

Markets may remain volatile for some time, but one year from now we expect stock prices to be higher than where they are today.”

6. Original: Value and cyclicals outperform growth and defensive stocks.
Scorecard for heading in the wrong direction

Update: Value and cyclicals outperform growth and defensive stocks in the second half.
Scorecard for too early to call
As of now, the Russell 1000 Value Index (-16.3%) is significantly trailing the Russell 1000 Growth Index (+9.8%), and cyclical sectors (-8.4%) are slightly behind defensive sectors (-6.5%).1 As the economy continues to recover, we think value and cyclical areas should do better in the second half of the year.

7. Original: Financials, technology and health care outperform utilities, real estate and consumer discretionary.
Scorecard for heading in the right direction

Update: Financials, technology and health care outperform utilities, energy and materials in the second half.
Scorecard for too early to call
For our original prediction, a basket of financials, technology and health care is down -3.2%, while one of utilities, real estate and consumer discretionary is trailing at -4.1%.1 Regarding our revised prediction, our list of favored asset classes didn’t change, and a basket of our least-favored asset classes is down significantly at -17.8% for the year.1 Technology and health care should continue to do well in an environment of quantitative easing, and financials as a sector appears undervalued to us.

8. Active equity managers outperform their indexes for the first time in a decade.
Scorecard for heading in the right direction
This is the second of our predictions that did not change. As of the end of May, just over half of large cap U.S. managers beat their indexes.3 We think opportunities for active management from here are relatively high. In our experience, active managers generally have a tailwind when small stocks beat big stocks, non-U.S. stocks outperform, equity returns are relatively low, value beats growth, correlations are low, economic growth improves and interest rates rise. We think most of that will happen in the second half of 2020.

9. The cold wars within the U.S. and between the U.S. and China continue.
Scorecard for heading in the right direction
This is our third unchanged prediction. And, sadly, it is one that is proving to be correct. An optimist would hope that Americans would have used this time of crisis to pull together, but the opposite seems to be the case as political and social divisions within the United States have worsened since the start of the crisis. And the relationship between the U.S. and China appears to be deteriorating as the countries move from being competitors to adversaries.

Investors should focus on selectivity, be nimble and flexible and rely on diligent research to uncover opportunities.”

10. Original: The U.S. concludes a tumultuous political year with a status quo election.
Scorecard for too early to call

Update: The coronavirus recession and rise in unemployment cause Donald Trump to be a one-term president.
Scorecard for too early to call
President Trump’s popularity and poll numbers have been dropping sharply in recent months, and the possibilities of a Democratic sweep of the White House and Congress are growing. Four months is a long time in politics, and we could see trends change. Should a sweep occur, it would represent a substantial change in the government’s tax and regulatory policies that could have significant implications for financial markets.
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Dimitri Stathopoulos
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Sources
1 Bloomberg, FactSet and Morningstar Direct
2 Credit Suisse
3 Bank of America Merrill Lynch

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.

Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

Glossary
The S&P 500® Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000® Index measures the performance of approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of a selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income. The Russell 1000® Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The Russell 1000® Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.

A word on risk
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. An alternative strategy sells securities that it has borrowed but does not own (“short sales”), which is a speculative technique. A strategy will suffer a loss when the price of a security that it holds long decreases or the price of a security that it has sold short increases. Losses on short sales arise from increases in the value of the security sold short, and therefore are theoretically unlimited. Because a strategy invests in both long and short equity positions, the strategy has overall exposure to changes in value of equity securities that is far greater than its net asset value. This may magnify gains and losses and increase the volatility of returns. In addition, the use of short sales will increase expenses. Diversification does not assure a profit or protect against a loss. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.

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